Can You Move Appreciated Stocks Into an ETF Without Paying Capital Gains Tax? Why the IRS Is Taking a Closer Look

Your portfolio has grown substantially. Selling would free you to change the investments, but it would also bring a capital-gains tax bill. An adviser suggests contributing the holdings to an exchange-traded fund instead.

The appeal is clear: keep more capital invested while changing the way you own it. The tax result needs a closer examination than the sales presentation.

A properly qualifying Section 351 contribution may defer recognition of gain. It does not automatically eliminate the gain, and contributing appreciated stocks to an ETF is not enough by itself to qualify. The IRS’s 2026 guidance challenges a particular planned exchange of portfolios through an ETF; it does not declare every Section 351 exchange invalid.

The decision is whether the actual transaction qualifies—and whether its investment terms and costs make sense even after the tax analysis.

What Section 351 actually allows

Internal Revenue Code Section 351(a) generally provides nonrecognition when one or more people transfer property to a corporation solely for its stock and the transferors control it immediately afterward. Section 368(c) defines control using an 80% voting-power and other-stock test.

For a fund launch, the relevant contribution group and timing need analysis; each individual contributor does not necessarily need to own 80% alone. Buying existing ETF shares on an exchange is a different transaction.

Section 351(e) adds an investment-company limitation. The Treasury regulations, particularly §1.351-1(c), connect that limitation to diversification and provide treatment for contributions where each transferor supplies an already diversified portfolio.

That is why “I own appreciated stocks” is the start of the eligibility review, rather than its conclusion.

Diversification must be tested before relying on the strategy

The regulatory diversified-portfolio route generally uses two limits: no more than 25% of value in one issuer and no more than 50% in five or fewer issuers. Related-issuer, fund look-through and other applicable rules can affect the calculation.

Consider an illustrative $3 million portfolio of 12 unrelated ordinary corporate issuers, each worth $250,000. Assume no special aggregation or look-through issues. One issuer represents about 8.33%; five represent about 41.67%. Those simplified percentages are within the two limits.

Now consider a different portfolio with 40% in one company. It fails the single-issuer limit for that diversified-portfolio route. The fact that the receiving ETF intends to hold hundreds of securities does not repair the contributing portfolio’s calculation.

Neither example establishes that a proposed exchange qualifies. The adviser and tax team still need to examine all the requirements and the planned steps.

What the IRS ruling challenges

Revenue Ruling 2026-20 considers an investor contributing an appreciated, already diversified portfolio to a newly formed ETF. Under the same plan, an authorized participant supplies different securities or cash, receives ETF shares, and shortly afterward redeems them for securities the original investor contributed. The ETF ends up holding a materially different portfolio aligned with its investment thesis.

The IRS applies substance-over-form and step-transaction principles. It treats the investor as making a taxable exchange with the authorized participant for the contributed securities used in that redemption. The holding also applies when multiple investors participate.

The important point is that the contributed portfolio in the ruling already satisfied diversification requirements. The IRS nevertheless challenged the integrated arrangement. Passing the concentration tests did not resolve the separate question about the transaction’s substance.

For clients, the practical question is: What is planned to happen to my securities after the ETF receives them? Ask for an explanation covering the entire arrangement, including contemplated in-kind redemptions. An arbitrary waiting period does not establish that planned steps are unrelated.

A revenue ruling and a request for comments do different things

Notice 2026-62 requests information about potentially abusive investment-fund strategies and discusses possible future guidance or other action. It also says the IRS may challenge abusive arrangements under existing law. Written comments are requested by October 28, 2026.

The notice’s discussion of possible future action should not be confused with a final regulation imposing every contemplated measure. The revenue ruling, meanwhile, states the IRS’s application of existing law to its described facts. It should not be dismissed merely because additional guidance remains under consideration.

The October 19, 2026 Internal Revenue Bulletin publishes both documents. For a proposed transaction, tax counsel should identify which authorities apply, how the facts compare and what remains uncertain. A promoter’s general description of “IRS-compliant” treatment is not that analysis.

Deferring a $500,000 bill is different from eliminating it

Assume a U.S. individual has investments worth $3 million, with $1 million adjusted tax basis. For this simplified illustration, assume the entire $2 million gain would be taxable on sale at a combined 25% effective rate. This assumed rate is not a statement of the reader’s federal or state tax rate. Ignore fees, losses and other adjustments initially.

Hypothetical outcome	Immediate gain recognition	Immediate tax at assumed 25%
Sell all holdings for cash	$2,000,000	$500,000
Complete a fully qualifying, stock-only Section 351 contribution with no other recognition trigger	$0	$0
Complete a transaction that is fully taxable on these assumed facts	$2,000,000	$500,000

The final row assumes the whole portfolio is taxable; it does not mean every transaction addressed by the ruling necessarily produces tax on every contributed security. The ruling’s holding concerns the contributed securities used to redeem the authorized participant.

Under Section 358, basis generally carries into the stock received in a qualifying nonrecognition exchange, subject to applicable adjustments. In the simplified qualifying example, the ETF shares retain $1 million basis, rather than receiving a $3 million reset.

If those shares later sell for $3.3 million, the assumed gain is $2.3 million. At the same illustrative 25% rate, the resulting tax would be $575,000. Actual outcomes depend on later events and applicable law.

The immediate benefit in the qualifying example is the timing of recognition. The investor also exchanges direct ownership of the holdings for an interest in the fund.

Put the investment economics beside the tax analysis

A substantial deferral can still be a poor fit if the fund does not suit your goals or the costs consume too much value.

For scale, an assumed incremental annual cost of 0.60% on $3 million is $18,000 at an unchanged account value. That is an arithmetic illustration, not a quoted ETF fee. Compare the actual fund expenses, advisory charges and transaction costs with the alternative you would otherwise use. Show who receives each payment and avoid counting overlapping charges twice.

Model the period over which you expect to hold the investment and when cash may be needed. Ask the investment adviser how the fund’s mandate, liquidity, trading costs and potential distributions fit that plan. Tax deferral should be evaluated alongside the exposure you will actually own.

Before committing, your tax team needs tax-lot basis and holding-period records, the contribution agreement, fund documents, the control analysis and an account of planned post-contribution transactions. Ask counsel for a written explanation addressing Revenue Ruling 2026-20 and the proposed arrangement’s differences or similarities. Ask whose facts and representations any opinion relies on.

If you already completed an exchange, preserve those materials and discuss the transaction with your tax adviser. A fresh headline alone is not enough to determine whether an amended return is appropriate.

Make the tax decision before transferring the securities

The useful question is whether the complete arrangement supports the claimed result, with records you can retain and economics you are comfortable owning.

McGregor Financial Services’ Personal CFO services help organize financial information and coordinate with existing advisers. Contact MFS to bring the tax basis, liquidity needs and financial commitments into the discussion with your investment adviser and transaction tax counsel before an appreciated portfolio is transferred.

General U.S. federal tax information as of October 23, 2026. Examples are hypothetical. Eligibility, recognition, reporting and state treatment require analysis of the actual transaction. MFS’s financial coordination does not include investment management or a substitute for transaction-specific legal advice.

Sources

• Internal Revenue Code Section 351
• Internal Revenue Code Section 368(c)
• Treasury Regulation §1.351-1
• Revenue Ruling 2026-20
• Notice 2026-62
• Internal Revenue Bulletin 2026-43
• Internal Revenue Code Section 358

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