Exchange fund

An exchange fund, also known as a swap fund, is an investment vehicle that allows investors with large stock positions to pool their stocks into a single fund, diversifying their holdings without triggering a taxable event. Given its dependence on the IRS Tax Code, it is a mechanism specific to the U.S., first introduced as early as 1954 with the passage of 26 U.S. Code § 721^[1] though the practice traces back to the 1930s through other tax provisions.

The primary benefit of this arrangement is to diversify a large stock position without triggering a "taxable event". Note that the tax is not avoided, just deferred. Deferring taxes avoids tax drag, as the money lost to taxes remains invested in the market, letting the portfolio compound from a larger base, which could create a significant advantage with time. When the diversified holdings are eventually sold, tax will be due on the difference between the sales price and the original cost basis of the contributed stock.