The IRS Targets Aggressive ETF Tax Strategies. Here's What It Means for Ordinary Index Investors

On September 28, 2026, Treasury and the IRS released a revenue ruling and a notice aimed at a handful of aggressive ETF and investment-fund tax strategies. Headlines have made it sound like a crackdown on ETFs generally. It isn't. The notice says that, except to the extent it discusses, it does not address ordinary-course ETF creation and redemption activity, which is the mechanism behind most ETFs' tax efficiency. The targets are specific structures, mostly used by wealthy investors with concentrated stock positions.

What the IRS actually released

• Revenue Ruling 2026-20 concludes that a "351 conversion transaction" is a taxable exchange, not a tax-deferred one. This is the one concrete ruling.
• Notice 2026-62 describes other strategies the government considers possibly abusive, asks for public comment, and says future guidance is possible, including regulations or identifying a strategy as a "transaction of interest" or a "listed transaction." The notice itself says these transactions "are not the result of conventional, long-established tax planning."

Treasury Secretary Scott Bessent said Treasury is "serious about cracking down on transactions designed to dodge taxes," as quoted by law firms Mayer Brown and Morgan Lewis.

The 351 conversion, in plain English

Imagine an investor who holds a large, highly appreciated stock position. Selling would trigger a big capital gains bill. In the ruling's fact pattern, the investor contributes the appreciated shares to a newly formed ETF. An authorized participant, a large trading firm that creates and redeems ETF shares, receives ETF shares for securities or cash, and the ETF then redeems those shares by handing the participant the investor's original shares, in a distribution intended to be tax-free under section 852(b)(6) of the tax code. The investor is left holding a different, diversified ETF portfolio, and the aim is that the gain on the original shares is never recognized.

The IRS applied substance-over-form principles. It said the ETF was merely a conduit through which securities passed from the investor to the authorized participant, so the investor's transfer must be treated as a taxable exchange. InvestmentNews cites a tracker showing more than 100 ETFs seeded in-kind under section 351 since 2021, with more than $20 billion in launch assets. Law firms note that revenue rulings generally apply retroactively, so past transactions could be affected.

The other strategies on the list

What the notice leaves alone

The notice acknowledges that ETFs regularly engage in creation and redemption transactions and take the position that in-kind distributions result in nonrecognition of gain or loss. It says that, except as discussed, it does not address those ordinary distributions and expresses no view on them. It also treats in-kind seeding consistent with a fund's investment thesis, where the assets are intended to be kept, differently from the flagged structures, according to Morgan Lewis. That firm cautions that the line between ordinary activity and the described transactions isn't fully defined.

For someone holding a plain index ETF, nothing in the notice says their holdings are in question. That is a reading of the guidance, not tax advice, and the details of any individual situation matter.

Who should pay attention

• Anyone who has used or been offered a 351 exchange ETF or an exchange fund to diversify a concentrated position.
• Holders of box spread or similar structured ETFs, and of tax-aware separately managed accounts or funds that use currency forwards, straddles, or swaps.
• Financial advisors and fund sponsors who sell these products. Senior Treasury officials warned about tax-aware products at a July 21 industry gathering, and Secretary Bessent posted about the issue on July 22, InvestmentNews reports.

If any of those describe you, ask your tax professional what the guidance means for your specific holdings and keep good records of the transactions. Comments on Notice 2026-62 are due October 28, 2026, and can be filed at regulations.gov under docket IRS-2026-1255.

Common questions

Does the IRS ETF notice affect my index fund ETF?

Nothing in Notice 2026-62 says so. The notice states that, except to the extent it discusses, it does not address ordinary-course ETF creation and redemption and expresses no view on those transactions. The flagged strategies are specific structures, such as 351 conversions and box spread funds. This is a reading of the guidance, not tax advice.

What is a 351 conversion transaction?

It is a strategy in which an investor contributes appreciated securities to a newly formed ETF, in a structure intended to let the investor diversify without recognizing the gain. Revenue Ruling 2026-20 says the IRS will treat it as a taxable exchange.

What is section 852(b)(6)?

It is a provision of the tax code that, in certain cases, lets a regulated investment company, such as a mutual fund or ETF, distribute appreciated property in redemption of its stock at the shareholder's demand without recognizing gain. The notice targets uses of it that, in the IRS's view, produce results inconsistent with the provision's purpose.

When are comments on the IRS notice due?

October 28, 2026. Comments can be submitted electronically at regulations.gov under docket IRS-2026-1255, or by mail to the address in the notice.