The U.S. Treasury Department and the Internal Revenue Service on Sept. 28 released Notice 2026-62, identifying several investment-fund tax strategies as potentially abusive. According to the notice and a Bloomberg report cited in the source article, the review covers 351 conversions, Box Spread ETFs, and derivatives trades used by hedge funds and other tax-oriented vehicles. Treasury and the IRS also issued Revenue Ruling 2026-20 the same day, concluding that certain 351 conversions should be taxed.
On Wall Street, these structures are often described as "Tax Alpha" trades because they aim to boost after-tax returns by cutting the investor's tax bill. The IRS did not name any product or issuer in the notice, but it divided the strategies into two broad groups: ETF structures that rely on in-kind redemptions, and funds that use derivatives to create losses that can offset other income.
Bloomberg reported that Treasury officials had already described similar transactions at an industry conference in July as looking "too good to be true." Treasury Secretary Scott Bessent wrote on X that the notice "makes it clear Treasury is serious about cracking down on transactions designed to avoid taxes through abuse of federal tax law."
Certain 351 ETF conversions are now treated as taxable
The term "351 conversion" comes from Section 351 of the U.S. tax code, which generally allows investors to transfer assets to a corporation in exchange for shares without immediately recognizing capital gains. Capital gains, in this context, are the difference between sale price and cost basis, and tax is due when those gains are recognized.
The IRS described a structure in which an investor contributes appreciated stock to a newly formed ETF and receives fund shares in return. If the contributed portfolio is sufficiently diversified, the transfer can initially qualify for nonrecognition. The thresholds described in the notice are that no single company exceeds 25% of the basket and the top five positions together do not exceed 50%.
The ETF then uses in-kind redemption to move those stocks out, delivering them directly to an authorized participant rather than selling them for cash in the market. Under Section 852(b)(6), a fund generally does not recognize gain when it distributes appreciated securities through an in-kind redemption. The IRS said that in many cases these steps are completed shortly after the assets are contributed, allowing the investor to end up with a materially different portfolio without paying tax.
Revenue Ruling 2026-20 says that when the deal is prearranged, the transaction should be recast based on its substance. In that analysis, the ETF is treated as a conduit, and the investor is treated as having directly exchanged stock with the authorized participant. That makes the exchange taxable.
The IRS also said the ruling does not cover situations where investors seed a new ETF with assets that fit the fund's investment strategy and are intended to be held for the long term. Routine ETF creations and redemptions were also left outside the scope of this action.
The notice separately flagged a variation in which an investor holding an insufficiently diversified stock position first contributes that stock to a partnership-style exchange fund, and the exchange fund then completes the 351 conversion. The IRS said it is still considering how to address that structure.
Bloomberg reported that Wall Street has turned 351 conversions into a business worth about $23 billion. One example in the report was the Twin Oak Active Opportunities ETF, ticker TSPX. When it launched in February 2025, the fund had about $450 million in assets, including roughly $200 million of embedded gains. Within a week of launch, its Snowflake and Datadog positions were swapped into an S&P 500 fund.
Wes Gray, chief executive of Alpha Architect, told Bloomberg that the ruling still appears to leave room for ETFs that genuinely intend to hold contributed stock. "You probably shouldn't dump 100 U.S. stocks into an ETF and one week later turn it into international bonds," he said. Jeffrey Hochberg, a partner at Sullivan & Cromwell, said there is still "significant uncertainty" over timing when an ETF is expected in advance to move the contributed securities out.
Box Spread ETFs and derivatives funds remain under review
Notice 2026-62 also singled out Box Spread ETFs. A box spread uses four options positions on the same underlying asset and produces a fixed payoff at expiration that closely tracks short-term interest rates. The IRS said some ETFs use the structure to earn returns similar to U.S. Treasurys, then distribute positions with built-in gains through in-kind redemptions before the options expire, arguing that no income needs to be recognized.
These ETFs often do not make cash distributions, with returns instead showing up in net asset value. Investors then pay capital gains tax when they sell, based on the holding period. Bloomberg said the largest fund in this category is Alpha Architect's 1-3 Month Box ETF, ticker BOXX, with about $15 billion in assets.
The source article included a simplified tax comparison. On a $1 million investment earning 5% annually, a $50,000 return treated as Treasury interest could face a top federal income tax rate of 37% plus the 3.8% net investment income tax, producing roughly $20,400 in tax. If the investor held the position for more than one year and the gain qualified as a long-term capital gain, the rate would be 20% plus 3.8%, or about $11,900 in tax, a difference of roughly $8,500. If the position is sold in less than a year, the rate matches ordinary income. The article also noted that selling later defers tax rather than eliminating it, and the example does not include state tax.
The notice mentioned two more ETF-related arrangements. One involves switching from one ETF into another ETF tracking the same index before a distribution date, with the aim of avoiding dividend income. The other involves ETFs that hold commodities or digital assets directly or through a trust, then use in-kind redemptions to deliver appreciated positions out of the fund.
Under U.S. tax law, regulated investment companies, or RICs, must derive at least 90% of gross income from qualifying sources such as dividends, interest and gains from securities transactions in order to use the RIC tax regime. Funds that qualify generally do not pay income tax at the fund level. The IRS said gains from selling commodities or digital assets are not qualifying income, and some ETFs appear to rely on in-kind redemptions to keep those gains out of the calculation.
The second major category in the notice covers tax-oriented funds, many of them structured as investment partnerships or separately managed accounts. Treasury and the IRS said these strategies build offsetting long and short positions, then choose which side to close first and what tax elections to make. The result can be ordinary losses that offset wages, interest and other ordinary income, while gains are pushed into capital gains treatment or deferred.
The notice described three examples. One uses foreign-exchange forward contracts together with futures to create an identified straddle. Another waits until after the trading day ends to decide whether gains on foreign-exchange forwards should be treated as capital gains, with the IRS noting the fund already knows which choice is more favorable when making that election. A third strategy terminates gain-bearing swap positions early while holding loss positions until the payment date.
Bloomberg reported that this type of trade is central to AQR Capital Management's Delphi Plus strategy. Documents obtained by Bloomberg showed that AQR TA Delphi Plus Fund had about $6.6 billion at the end of June, and that ordinary losses recognized in 2025 were equal to 28% of invested capital. Kevin Salinger, deputy assistant secretary for tax policy at Treasury, said in July that he had seen marketing materials claiming that "if you invest $1 million, you may get $300,000 of ordinary losses."
The notice also stated that a long-standing year-end practice of selling stocks with unrealized losses while retaining stocks with unrealized gains is consistent with congressional intent. Treasury and the IRS said a strategy is not suspect simply because it is described as tax-oriented.
Comment deadline is Oct. 28, and later guidance may be retroactive
Treasury and the IRS asked market participants to submit comments by Oct. 28, including whether the notice accurately describes the transactions and which related transactions are economically different. The agencies said they may follow with regulations, additional notices or revenue rulings. Some transactions could also be designated as a transaction of interest or a listed transaction. Bloomberg reported that a transaction-of-interest designation would trigger added disclosure requirements.
The notice says later guidance could apply only to future transactions, but it could also apply to transactions completed before the guidance is issued. The IRS also said it can challenge abusive investment strategies under existing law during an audit. Treasury and the IRS said any guidance will target specific abusive transactions while trying to limit compliance burdens.
Brent Sullivan, who runs the Tax Alpha Insider blog, told Bloomberg that 351 conversions are the most concrete part of the package and that Treasury is still gathering information on the other items. Whether those other strategies will be formally listed, and from what date any action would apply, will depend on later guidance. Treasury and the IRS have not published a timetable.