IRS signals potential crackdown on AQR-linked tax-aware trading strategy

The US Internal Revenue Service has signalled a potential crackdown on investment strategies designed to generate losses that can be used to offset ordinary income, putting a spotlight on an approach popularised by hedge fund giant AQR Capital Management, according to a report by Bloomberg.The IRS said it plans to issue guidance and could take further action to restrict certain transactions used by money managers to help clients reduce their tax liabilities. The agency specifically identified some currency transactions and structures combining equity swaps with futures as areas under review.AQR's Delphi Plus strategy is among the best-known approaches designed to generate tax benefits from trading activity. The firm's AQR TA Delphi Plus Fund had approximately $6.6bn in assets at the middle of this year, according to documents reviewed by Bloomberg.The strategy forms part of a broader expansion of tax-aware investing, in which hedge funds use long-short portfolios to harvest losses while maintaining exposure to markets. The approach has traditionally focused on reducing investors' capital-gains tax bills, but strategies aimed at offsetting ordinary income have attracted increasing attention.Industry estimates suggest tax-aware long-short strategies have attracted more than $150bn over the past three years. These approaches generally involve maintaining long and short positions and realising losing investments for tax purposes while allowing profitable positions to remain invested.The IRS said broad stock-focused strategies can in some circumstances be consistent with established methods of managing tax liabilities. However, the agency expressed concern about transactions where tax considerations appear to be the primary motivation rather than investment returns.The agency's warning could have particular significance for strategies seeking to generate ordinary losses, which can potentially offset income such as wages, salaries and bonuses rather than only capital gains.AQR has previously said it modifies its strategies to comply with applicable regulations and guidance. The firm reportedly did not comment specifically on the latest IRS announcement.