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Yes—properly structured Section 351 ETF seed transactions remain possible after the IRS issued new guidance on September 28, 2026. Notice 2026-62 and Revenue Ruling 2026-20 target arrangements that appear to contribute appreciated securities and then quickly replace them through ETF creation and redemption. They do not declare every Section 351 ETF transaction invalid.
The practical dividing line is whether the ETF is genuinely being seeded with assets that fit its investment strategy and is expected to retain them, or whether the steps were prearranged to swap an investor’s portfolio for a materially different one without recognizing gain.
What the September 2026 IRS guidance changed
On September 28, 2026, the Treasury Department and IRS released Notice 2026-62 together with Revenue Ruling 2026-20. The notice describes novel investment-fund strategies that could produce tax results inconsistent with federal law and asks for comments on those transactions and similar arrangements. Written comments are due October 28, 2026, according to InvestmentNews’ report on the consultation.
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The transaction the IRS rejected
Revenue Ruling 2026-20 addresses a planned sequence in which investors contribute appreciated securities to a new ETF. The ETF issues creation units to an authorized participant in exchange for securities matching the ETF’s thesis—or cash used to buy those securities. The ETF then redeems the units using the investors’ original securities. The IRS says that sequence is properly characterized as a taxable exchange between the contributing investors and the authorized participant, not as a qualifying Section 351 contribution to the ETF.
In substance, the concern is that the contribution and immediate creation-and-redemption steps operate as a prearranged portfolio swap. Calling the first step a contribution does not by itself make the overall exchange tax-free.
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What the notice says can still qualify
Notice 2026-62 expressly says it does not address, and takes no position on, a Section 351 transaction used to seed a newly established ETF with assets consistent with the fund’s investment thesis when the ETF intends and expects to retain those assets absent a substantial change in circumstances.
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Section 351(a) generally provides nonrecognition when property is transferred to a corporation solely for its stock and the transferors control the corporation immediately after the exchange. Section 351(e) limits that rule for transfers to an investment company. An ETF seed therefore has to satisfy the statutory requirements and fit the transaction’s real economic purpose, not merely its paperwork.
Control and diversification tests
- Control immediately after the exchange: the transferors must meet Section 351’s control requirement at that point in the transaction.
- Diversification: the IRS notice explains that a portfolio is generally diversified when no more than 25% of its value is invested in one issuer and no more than 50% is invested in five or fewer issuers.
- Investment-company limitation: Section 351(e) can prevent nonrecognition for transfers to an investment company, so the fund’s structure and holdings require transaction-specific analysis.
- Business purpose and retention: contributed assets should match the ETF’s stated strategy and be intended for retention, rather than serving as temporary inventory for an immediate replacement.
Conventional seed versus targeted conversion structure
The following distinctions explain why the IRS can view two transactions that both use Section 351 as materially different.
| Issue | Conventional Section 351 ETF seed | Targeted conversion structure described by the IRS |
|---|---|---|
| Fit with ETF thesis | Assets contributed are consistent with the newly launched ETF’s stated investment strategy. | Investors contribute appreciated assets, while the ETF receives different securities aligned with a thesis or cash to buy them. |
| Expected retention | The ETF intends and expects to retain the contributed assets unless circumstances substantially change. | The original assets are positioned to return through a planned redemption sequence. |
| Control and diversification | Transferors must satisfy the immediate-control requirement and applicable diversification limits. | Meeting formal thresholds does not cure a transaction that is substantively a prearranged exchange. |
| Creation and redemption | Creation units support the fund’s launch and portfolio construction without a predetermined portfolio swap. | Rapid creation followed by redemption effectively replaces one portfolio with another. |
| Tax result | Potential nonrecognition under Section 351 if all requirements are met. | IRS position is that the arrangement is a taxable exchange between investors and the authorized participant. |
| Investment minimum and fund history | Minimums are usually larger than many clients will commit, and a new fund has no operating history to evaluate. | Exact minimums and operating history are not stated; the same practical issues remain relevant. |
| Future guidance | Conventional, long-established planning is intended to receive consideration, although the final scope is unsettled. | Future rules could include listed-transaction treatment and could be prospective or retroactive. |
Can a single appreciated stock position be contributed?
Usually, that is not the ordinary fact pattern. Tim Steffen, managing director and director of advanced planning at Baird Private Wealth Management, told InvestmentNews that clients often assume one highly appreciated company holding can simply be exchanged for an ETF. He said the portfolio generally must be diversified, and the Section 351(e) limits make a single concentrated position difficult to fit.
Steffen also noted that minimum investments are commonly larger than many clients are willing to commit. A newly launched ETF has no operating history, so an investor must assess an untested strategy, portfolio construction and governance while also analyzing the tax rules.
Tax deferral is not tax elimination
Even a transaction that qualifies for Section 351 nonrecognition generally defers gain rather than erasing it. Steffen’s warning is direct: “This is simply a tax deferral technique. It’s not a tax elimination technique.” The deferred tax can become relevant when the ETF shares or other property are later sold, and the eventual result depends on basis, holding period, distributions and the investor’s circumstances.
That distinction matters when comparing a valid seed transaction with an arrangement promoted primarily for an immediate tax result. Steffen said, “If you’re going to promote a product that has tax advantages, you need to understand the disadvantages too. How can these things go right and how can they go wrong?”
Independent reader supportYour contribution helps us test, update, and keep practical guides available for everyone.How widespread are Section 351 ETF seeds?
More than 100 ETFs have been seeded in kind under Section 351 since 2021, representing more than $40 billion in current assets under management, according to the Tax Alpha Insider tracker in figures reported by InvestmentNews in 2026.
An earlier InvestmentNews report dated September 29 cited more than $20 billion in launch assets under management for more than 100 ETFs seeded since 2021, also citing that tracker. Those figures describe different points in time—current assets versus assets at launch—and should not be treated as interchangeable.
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- Map every step: document the contribution, issuance of creation units, authorized-participant role, purchases, redemptions and timing. A prearranged sequence can change the tax characterization.
- Test the portfolio: calculate issuer concentrations using the 25% single-issuer and 50% five-or-fewer-issuers standards described in Notice 2026-62.
- Confirm the fund’s purpose: show how the contributed assets match the ETF’s investment thesis and why the fund expects to retain them.
- Check control and Section 351(e): obtain a written analysis of immediate control and the investment-company limitation rather than relying on a product presentation.
- Model the deferred tax: determine how basis, later sales, distributions and potential changes in law affect the eventual liability.
- Review the fund itself: weigh minimum investment requirements and the fact that a new ETF lacks an operating record.
- Get independent advice: have a qualified CPA, tax attorney or fiduciary adviser review the exact documents and facts before contributing property.
Baird does not offer Section 351 products, according to Steffen. He said clients and advisers he has walked through the details generally concluded the strategy was not a fit, while acknowledging that it can be appropriate in some circumstances.
What happens next
The Treasury Department and IRS say any future guidance is intended to target specific abusive transactions, minimize compliance burdens and respect conventional, long-established tax planning consistent with congressional intent. Until that guidance is issued, the legality of a proposed ETF seed depends on its complete structure and economic substance, not simply on using the label “351 exchange.”
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