Treasury Asked to Clarify Fast-Growing ETF “351 Conversion” Tax Strategy

The Investment Company Institute (ICI) has submitted a formal comment letter to the U.S. Treasury Department seeking guidance on “351 conversions,” a strategy that lets investors move concentrated stock positions or entire portfolios into exchange-traded funds (ETFs) without triggering immediate capital-gains taxes. ICI’s request follows two meetings with Treasury officials in which the agency reportedly considered labeling certain conversions a “transaction of interest” for potential tax-avoidance concerns.

Bloomberg

351 conversions belong to a broader set of tax-optimization techniques used on Wall Street. The method exploits an ETF industry loophole: securities are seeded into a newly created ETF, which then swaps them for fresh assets, allowing portfolio rebalancing without a taxable event. Bloomberg reported that an ETF used the tactic to replace roughly 40 % of its holdings—two tech stocks—with an S&P 500-tracking fund within days of listing. Treasury has been in early discussions about increasing scrutiny of such practices.

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• Investment Company Institute (ICI): Industry association representing more than $45 trillion in assets across funds managed by firms such as BlackRock Inc. and Vanguard Group.

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• Mike Horn: Deputy General Counsel of ICI, the primary spokesperson in the Treasury meetings.

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• U.S. Treasury Department: Federal agency evaluating whether to treat 351 conversions as transactions of interest and to issue formal guidance.

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• ICI’s membership collectively oversees over $45 trillion in assets.

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• 351 conversions enable the transfer of concentrated stock positions or entire portfolios into ETFs without immediate capital-gains liability.

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• In a documented case, an ETF swapped about 40 % of its portfolio shortly after launch.

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The strategy could affect federal tax revenue by deferring or reducing capital-gains collections. It also raises fairness questions for investors who lack access to sophisticated tax-planning tools. Clarifying the regulatory stance would influence fee structures, competitive dynamics among fund managers, and the broader market’s reliance on tax-driven portfolio adjustments.

Bloomberg

ICI’s comment letter urges Treasury to provide clear rules, emphasizing that many members seek consistency rather than a blanket prohibition. Treasury officials have not responded to the request for comment, but internal discussions have explored designating certain conversions as “transactions of interest.” Bloomberg noted that Treasury previously contemplated “shutting this down in some form or another.” ICI also highlighted the non-tax benefits of 351 conversions and the competitive fee environment as reasons to avoid a total ban.

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Treasury’s consideration of a “transaction of interest” label reflects concerns that some conversions may be primarily tax-avoidance tools. ICI acknowledges that “some transactions are problematic” but argues that the practice also serves legitimate investment purposes, urging regulators to target abusive cases rather than eliminate the entire strategy.

Bloomberg

• “It’s a little risky because when we ask for guidance, we can’t control what we get,” — Mike Horn, Deputy General Counsel, ICI

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• “A lot of our members who are seeing this and are saying ‘there’s a lot of variation, we want to know the rules, just tell us the rules.’” — Mike Horn, ICI

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• “In the meetings with the Treasury, both parties agreed that investors should not contribute securities to an ETF with no intent to hold them post-conversion, Horn said.” — Mike Horn, ICI

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• “Yes, some transactions are problematic, but the practice itself has legitimate, non-tax reasons. Therefore, don’t shut down the entire industry. Instead, target the abusive cases,” — Mike Horn, ICI

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• “I think that message was heard and understood.” — Mike Horn, ICI

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Treasury continues to assess 351 conversions and may issue formal guidance or adopt the “transaction of interest” designation. ICI will monitor the outcome and adjust its advocacy accordingly, while market participants await clarification to determine how to structure future ETF transactions.

Bloomberg