Treasury Secretary Bessent Backs IRS Ruling on ETF Tax Avoidance Strategies

Treasury Secretary Scott Bessent has publicly supported a new IRS revenue ruling aimed at closing a loophole that allowed investors to avoid taxes on appreciated securities within Exchange Traded Funds (ETFs). The guidance, issued on September 28, 2026, targets prearranged transactions designed to swap appreciated assets for different holdings without immediately recognizing built-in gains. This move signals a clear message from the government that such tax avoidance schemes will be challenged under existing law.

The core of the issue lies in how certain investors have used the creation and redemption mechanics of ETFs as part of a tax strategy. While ordinary ETF operations and standard tax deferral methods remain unaffected, the IRS is focusing on coordinated transactions that exploit these rules for personal gain. The Treasury and IRS have issued Revenue Ruling 2026-20 and Notice 2026-62 to address these specific arrangements.

How the ETF Conversion Strategy Works

The strategy in question often begins when an investor contributes a basket of securities, which may have significantly increased in value, to a newly formed ETF. This contribution can sometimes happen through an intermediary. The key element is that these appreciated assets are then rapidly distributed or swapped out of the fund shortly after they are contributed.

This process allows the investor to end up with a portfolio that is “materially different” from the original one, while the capital gains embedded in the initial securities have not yet been taxed. The IRS views some of these arrangements as merely a “conduit” to move securities in a way that bypasses tax obligations. The scrutiny is specifically on this coordinated sequence of events, not on the general act of contributing assets to an ETF.

Existing ETF Tax Rules Remain Unchanged for Normal Operations

It is important to distinguish these targeted strategies from the standard operations of ETFs. ETFs are generally designed to allow for the deferral of capital gains within the fund itself. In certain “in-kind” redemption transactions, the fund does not immediately recognize gains, as permitted under Internal Revenue Code Section 852(b)(6).

This established feature is different from a preplanned scheme to contribute appreciated assets and then quickly exchange them for different holdings. The new guidance clarifies that standard ETF seeding and normal in-kind redemption processes are not the target, especially when they serve the fund’s ordinary operational needs. The IRS allows for seeding with assets that align with a fund’s investment strategy and are intended to be held long-term, though this treatment can change if circumstances shift.

Speed and Intent Signal Tax Avoidance

Fund managers must navigate a boundary that is determined by specific facts and circumstances. The speed at which a fund reshuffles contributed assets after they are received is a significant warning sign for the IRS. Additionally, the notice considers the intended role of the contributed assets and how they are treated later within the fund.

The agencies’ action is designed to counter investment strategies that allowed investors to defer capital gains while maintaining market exposure through new fund structures. This does not mean that all ETF contributions or in-kind redemptions will now trigger immediate taxes. Instead, it targets arrangements where the primary purpose appears to be tax avoidance through a series of carefully timed transactions.

Broader Strategies Under Review

The IRS notice extends its focus beyond basic ETF conversion arrangements. It also flags certain variations involving partnerships, such as Section 721 exchange-fund structures and transfers to partnerships that are linked to Section 351 transactions. Additionally, the notice identifies “box spread” strategies that use options and fund transactions timed around dividend record dates.

These are grouped with other “tax-motivated investment strategies.” Another area of concern involves structures using commodities or digital assets, where the IRS questions whether these arrangements aim to meet the 90% qualifying-income test through in-kind redemptions. These examples indicate a wider review of investment structures that combine fund rules with precisely timed transfers or exchanges, with the notice identifying the strategies and the ruling addressing the specific ETF conversion scenario.

Public Comment Period Open

As of early October 2026, the Treasury and IRS have released formal guidance and signaled increased enforcement. The notice still allows for compliant asset seeding and standard in-kind ETF operations. The distinction between legitimate fund operations and tax-avoidance transactions hinges on the specific facts, including how quickly contributed holdings are changed and whether those assets align with the fund’s investment purpose.

Wealthy investors and financial advisors who promote these types of strategies are among those being targeted by this crackdown. The agencies have requested public comments on Notice 2026-62 until October 28, 2026. This deadline allows for input while the new ruling and notice clearly outline the government’s current stance on these ETF tax avoidance schemes.

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