Key Takeaways
- • The Treasury Department and IRS issued Notice 2026-62 on September 28, flagging tax-motivated investment strategies in digital assets—a regulatory warning rather than an outright ban that requests information and leaves enforcement options open.
- • Revenue Ruling 2026-20 explicitly rejects prearranged Section 351 transactions where investors contribute appreciated securities to crypto ETFs and quickly redeem to avoid recognizing embedded gains, signaling that such conversions "don't work under existing law," according to Treasury Secretary Scott Bessent.
- • The IRS retains authority to challenge abusive investment-fund strategies during examinations under existing law without waiting for new rules, and may designate certain crypto arrangements as transactions of interest or listed transactions, triggering heightened reporting requirements.
- • In-kind redemption strategies in regulated investment companies—which must derive at least 90% of annual gross income from qualifying sources to maintain tax-favored status—face potential new regulations, additional rulings, or retroactive enforcement where legal authority permits.
- • The regulatory action arrives as in-kind ETF redemption volumes have expanded significantly, with the backdrop of $7.22 billion in related activity, reflecting accelerating use of these strategies across the crypto asset class.
Summary
On September 28, the Treasury Department and IRS jointly issued Notice 2026-62, flagging tax-motivated investment strategies involving digital assets that fund managers may be employing beyond their intended regulatory purpose. Treasury Secretary Scott Bessent announced the companion guidance in a social media post, emphasizing that the agencies are "serious about cracking down on transactions designed to dodge taxes or exploit our federal tax code." Critically, the notice is not a ban; rather, it represents a regulatory inquiry that requests information on the practice and explicitly leaves open what enforcement or guidance may follow.
The notice identifies in-kind redemption strategies used by regulated investment companies (RICs)—mutual funds and ETFs that must derive at least 90% of annual gross income from qualifying sources to retain their favorable tax treatment—as a primary area of concern. The IRS warned that potential responses could include new regulations, additional revenue rulings, formal guidance, or designating certain arrangements as transactions of interest or listed transactions, classifications that carry heightened disclosure and reporting obligations. Enforcement could be applied prospectively to future transactions or, where legal authority permits, retroactively to strategies already executed before new guidance is issued.
Simultaneously, Revenue Ruling 2026-20 rejected a specific abusive strategy: prearranged Section 351 transactions in which investors contribute appreciated securities to an ETF and execute a quick redemption, thereby obtaining a different portfolio composition without recognizing the embedded capital gain. Bessent stated explicitly that these Section 351 conversions "don't work under existing law," signaling that taxpayers pursuing such arrangements face disqualification under current tax provisions.
The IRS further cautioned that it reserves the right to challenge any abusive investment-fund strategy during a routine examination under existing statutory authority, without requiring new rulemaking. This positions examiners to scrutinize such transactions immediately, creating near-term compliance risk for fund sponsors and investors relying on these tax positions.
The regulatory action arrives as in-kind ETF redemption activity has grown rapidly within the crypto asset class, with $7.22 billion in related volume providing the backdrop for this intervention. The notice reflects an intensifying institutional focus on digital asset taxation and suggests that Treasury and the IRS view current market practices as inconsistent with congressional intent for tax-preferred fund structures.
The notice identifies in-kind redemption strategies used by regulated investment companies (RICs)—mutual funds and ETFs that must derive at least 90% of annual gross income from qualifying sources to retain their favorable tax treatment—as a primary area of concern. The IRS warned that potential responses could include new regulations, additional revenue rulings, formal guidance, or designating certain arrangements as transactions of interest or listed transactions, classifications that carry heightened disclosure and reporting obligations. Enforcement could be applied prospectively to future transactions or, where legal authority permits, retroactively to strategies already executed before new guidance is issued.
Simultaneously, Revenue Ruling 2026-20 rejected a specific abusive strategy: prearranged Section 351 transactions in which investors contribute appreciated securities to an ETF and execute a quick redemption, thereby obtaining a different portfolio composition without recognizing the embedded capital gain. Bessent stated explicitly that these Section 351 conversions "don't work under existing law," signaling that taxpayers pursuing such arrangements face disqualification under current tax provisions.
The IRS further cautioned that it reserves the right to challenge any abusive investment-fund strategy during a routine examination under existing statutory authority, without requiring new rulemaking. This positions examiners to scrutinize such transactions immediately, creating near-term compliance risk for fund sponsors and investors relying on these tax positions.
The regulatory action arrives as in-kind ETF redemption activity has grown rapidly within the crypto asset class, with $7.22 billion in related volume providing the backdrop for this intervention. The notice reflects an intensifying institutional focus on digital asset taxation and suggests that Treasury and the IRS view current market practices as inconsistent with congressional intent for tax-preferred fund structures.
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