Blog
Section 351 Conversions: From SMA To ETF
Daryn Levesque | 23 July 2026
As the exchange-traded fund (ETF) industry continues to evolve and expand, innovative methods for launching and seeding ETFs have emerged. Among these, the “351 Conversion” stands out as a strategic approach allowing separately managed accounts (SMAs) or other pooled investment vehicles to convert into an ETF.
What began as a niche technique has quickly become one of the more visible growth stories in the ETF industry. By May 2026, roughly 77 U.S. ETFs had launched via 351 conversion, bringing in an estimated $16.6 billion in seed assets from individual investors, and industry estimates put the pool of embedded gains that could eventually move through this structure at approximately $5 trillion. This blog explores the mechanics, benefits, regulatory considerations, and use cases of 351 conversions, along with what has changed as the strategy has matured.
A 351 conversion is a tax-deferred method of transferring an existing investment portfolio, typically an SMA, into an ETF. This conversion is based on Section 351 of the Internal Revenue Code, which allows a person to transfer property to a corporation in exchange for stock in that corporation without recognizing a gain or loss at the time of the transfer.
The key benefit of this structure is that it allows the transfer of appreciated assets into an ETF without triggering capital gains taxes at the point of conversion. Once the assets are inside the ETF wrapper, they can be traded in-kind — further minimizing tax implications for shareholders.
To qualify as a 351 transaction, the following conditions must be met:
Additionally, the ETF must meet diversification standards:
Sponsors should note that these thresholds are tested at the time of contribution, and many ETF sponsors build in an additional buffer — capping single positions closer to 20% rather than the statutory 25% — so that ordinary market movement after the transfer doesn’t inadvertently push the fund out of compliance. SEC rules also require that an incoming portfolio align with the ETF’s stated investment mandate, so a sponsor can decline a contribution that conflicts with the fund’s prospectus even if the diversification tests are otherwise satisfied.
Regulatory Scrutiny: Using 351 conversions primarily for tax deferral may attract attention from the IRS or SEC. The resulting ETF should be viable and attractive for new investors and growth. As conversions have scaled into the tens of billions of dollars, regulators and industry observers have increasingly cautioned against structures where the tax benefit is the only rationale for the ETF's existence — the fund still needs a genuine investment thesis that justifies allocation on its own merits, independent of the tax treatment.
351 conversions offer a compelling mechanism for converting existing portfolios into ETFs, delivering both operational and tax efficiencies. As interest in ETFs grows, particularly in light of wealth transfers, tax planning opportunities, and overall ETF tailwinds, this structure will likely become more prevalent. However, careful consideration of regulatory, structural, tax and other strategic factors is essential, and always be sure to involve service providers early and often.
The information contained in this document is provided for informational purposes only and does not constitute legal, tax, or investment advice. Readers should consult their own legal and tax advisors for guidance specific to their individual circumstances.
The content herein is subject to change without notice, and PINE makes no representations or warranties regarding the completeness or accuracy of the information. PINE is not liable for any decisions made or actions taken based on this material.
Contact us to start the conversation.
What began as a niche technique has quickly become one of the more visible growth stories in the ETF industry. By May 2026, roughly 77 U.S. ETFs had launched via 351 conversion, bringing in an estimated $16.6 billion in seed assets from individual investors, and industry estimates put the pool of embedded gains that could eventually move through this structure at approximately $5 trillion. This blog explores the mechanics, benefits, regulatory considerations, and use cases of 351 conversions, along with what has changed as the strategy has matured.
What is a 351 Conversion?
A 351 conversion is a tax-deferred method of transferring an existing investment portfolio, typically an SMA, into an ETF. This conversion is based on Section 351 of the Internal Revenue Code, which allows a person to transfer property to a corporation in exchange for stock in that corporation without recognizing a gain or loss at the time of the transfer.
The key benefit of this structure is that it allows the transfer of appreciated assets into an ETF without triggering capital gains taxes at the point of conversion. Once the assets are inside the ETF wrapper, they can be traded in-kind — further minimizing tax implications for shareholders.
Process Overview
- Seed Portfolio Identification: A fund or account with certain characteristics, such as significant capital appreciation and liquid holdings, is identified for conversion.
- ETF Creation: A new ETF is established, either in coordination with an existing multiple series trust or white-label provider or by creating a new trust structure.
- Asset Transfer: The assets from the SMA are transferred in-kind to the custodian and held in the name of the newly created ETF.
- ETF Share Issuance: Shares of the ETF are issued to the original SMA holder, based on the fair market value of the transferred assets.
- ETF Listing: The ETF lists with an exchange, market makers price and provide liquidity, and authorized participants can create and redeem shares of the ETF.
- Post-Launch Operations: The ETF can begin offloading appreciated securities and change portfolio constituents to meet its strategy through fund rebalances and generally behaves like other ETFs in the market.
Regulatory Requirements
To qualify as a 351 transaction, the following conditions must be met:
- The transferred assets must represent ‘property,’ generally comprised of marketable and liquid securities.
- The transferor (fund or account) must receive stock in the corporation (ETF).
- The transferor must own at least 80% of the new corporation immediately after the transfer.
Additionally, the ETF must meet diversification standards:
- No single security may exceed 25% of the value of the portfolio.
- The top five securities combined must not exceed 50% of the value of the portfolio.
Sponsors should note that these thresholds are tested at the time of contribution, and many ETF sponsors build in an additional buffer — capping single positions closer to 20% rather than the statutory 25% — so that ordinary market movement after the transfer doesn’t inadvertently push the fund out of compliance. SEC rules also require that an incoming portfolio align with the ETF’s stated investment mandate, so a sponsor can decline a contribution that conflicts with the fund’s prospectus even if the diversification tests are otherwise satisfied.
Benefits
- Tax Deferral: Investors avoid triggering capital gains on appreciated assets by virtue of the in-kind contribution to the ETF.
- Operational Efficiency: Assets are transferred in-kind, minimizing market disruption. The resulting ETF structure is generally viewed as efficient because it will continue to operate in-kind through the ongoing creation and redemption processes.
- Market Access: ETF wrapper generally offers liquidity, accessibility, and broader market exposure. ETFs are more easily bought and sold by investors than other fund structures and available through most brokerage accounts.
- Legacy Planning: Investors can transition appreciated assets into a tradable vehicle that can be passed to heirs.
- Business Value for Advisors: For RIAs, converting a book of SMAs into a proprietary ETF can also reshape the value of the advisory business itself. Independent RIAs often trade at roughly three to five times revenue, while ETF-centric businesses have recently commanded closer to eight to ten times revenue, giving advisors an additional strategic reason to consider the structure beyond tax deferral for their clients.
Use Cases
- High-Net-Worth Investors: SMA holders with significant capital gains seeking tax deferral and liquidity.
- Wealth Transfer Planning: Facilitates smoother intergenerational asset transfers.
- Portfolio Rebalancing: Enables rebalancing out of appreciated positions with reduced tax friction.
- Private to Public Strategy: Offers a path for previously private strategies to reach a wider investor base.
- RIA Consolidation: As advisory firms scale, managing hundreds of individual SMAs can strain trading, rebalancing, and compliance resources; a 351 exchange lets an advisor consolidate client assets into a single ETF using existing client capital rather than raising outside seed money.
Risks and Considerations
Regulatory Scrutiny: Using 351 conversions primarily for tax deferral may attract attention from the IRS or SEC. The resulting ETF should be viable and attractive for new investors and growth. As conversions have scaled into the tens of billions of dollars, regulators and industry observers have increasingly cautioned against structures where the tax benefit is the only rationale for the ETF's existence — the fund still needs a genuine investment thesis that justifies allocation on its own merits, independent of the tax treatment.
- Cost and Viability: Creating and operating an ETF requires capital and infrastructure, some of which can be overcome by the scale that may be brought with a conversion of existing assets. Managing an ETF, however, has a different cost structure than other wrappers.
- Education Gaps: Fund managers who sponsor other pooled vehicles may lack an operational understanding of ETF structures. The ETF landscape is unique, and the bifurcation between primary and secondary markets creates an environment unlike most other wrappers.
- Asset Limitations: Illiquid assets may not be eligible for in-kind transfers or general use in an ETF.
- Market Sensitivity: Much of the recent surge in conversions has been driven by years of broad market appreciation. A prolonged downturn could reduce the pool of investors with meaningful embedded gains to defer, which is a factor sponsors and advisors should weigh when assessing how durable this pipeline of conversions will be over a full market cycle.
351 conversions offer a compelling mechanism for converting existing portfolios into ETFs, delivering both operational and tax efficiencies. As interest in ETFs grows, particularly in light of wealth transfers, tax planning opportunities, and overall ETF tailwinds, this structure will likely become more prevalent. However, careful consideration of regulatory, structural, tax and other strategic factors is essential, and always be sure to involve service providers early and often.
The information contained in this document is provided for informational purposes only and does not constitute legal, tax, or investment advice. Readers should consult their own legal and tax advisors for guidance specific to their individual circumstances.
The content herein is subject to change without notice, and PINE makes no representations or warranties regarding the completeness or accuracy of the information. PINE is not liable for any decisions made or actions taken based on this material.
Thinking About Launching an ETF Through a 351 Conversion?
PINE helps fund sponsors navigate the operational, compliance, and administrative complexities of bringing ETFs to market. Whether you're evaluating a conversion or actively planning a launch, our team can help you assess your options and build a path forward.
Contact us to start the conversation.