The super-rich avoid capital gains taxes by borrowing against their appreciating assets instead of selling them. This allows them to fund their lifestyle tax-free. Since assets are only taxed upon sale, this deferral becomes permanent if they hold the assets until death, when the cost basis resets for heirs.

Regulators can use the "step transaction assessment" to collapse a series of individually legal actions into a single event. If the consolidated transaction's primary purpose appears to be tax avoidance, the IRS can challenge it, forcing the taxpayer to defend a weak position. This is a key risk in aggressive financial engineering.

The Section 351 tax code is intended for contributing an already diversified portfolio into a new ETF, not for taking a concentrated position and diversifying it tax-free. That latter goal is governed by the more restrictive Section 721, which often involves private partnerships and a seven-year holding period.

Immediately selling all contributed assets within a new 351 ETF lacks economic substance and can be viewed as part of a plan for tax-free diversification. A defensible approach involves a gradual, documented rebalancing process where every trade is justifiable for profit-seeking, non-tax reasons.

Investors with highly appreciated, concentrated stock can use financial products similar to real estate's 1031 exchange. They can pool their stock into a newly created, diversified ETF, deferring the capital gains tax event. This solves the immediate diversification risk, though the original low cost basis carries over.

When contributing assets to a 351 ETF, preserving the individual cost basis of each tax lot is critical. This "granularity" allows investors to strategically sell specific lots to manage tax liability. Averaging the cost basis destroys this information and eliminates a valuable tax asset, a practice followed by at least one large custodian.

Instead of selling assets and triggering capital gains, the wealthy buy and hold assets like stocks. They then borrow against that portfolio tax-free for living expenses. When they die, a life insurance policy pays off the loan, allowing the original assets to pass to heirs tax-free.

Collectors buy art, have it appraised at a much higher value, and then borrow against that new value. Since loans are not considered income, this provides them with millions in tax-free cash for other investments, all without selling the underlying asset.

To counter the "Buy, Borrow, Die" strategy, the act of borrowing against assets should be a taxable event. This proposal suggests taxing the unrealized gain on an asset at the moment it's pledged as collateral for a loan. This forces the wealthy to pay taxes on their gains without having to sell, raising significant revenue.