IRS Revenue Ruling 2026-20 treats a particular planned ETF seeding-and-redemption sequence as a taxable exchange between the contributing investor and an authorized participant (AP). IRS Notice 2026-62 identifies additional ETF and tax-aware fund strategies the government is studying, requests comments by October 28, 2026, and warns that further guidance or examination challenges are possible. Neither document says that ordinary ETF in-kind redemptions or tax-aware investing generally are improper.
What the ruling says about the ETF seed-and-redemption sequence
Revenue Ruling 2026-20, dated September 28, 2026, examines an investor contributing an appreciated, diversified securities portfolio to a newly formed ETF as part of a plan. The ETF also issues creation shares to an AP in exchange for securities or cash used to acquire securities consistent with the ETF’s investment thesis. Shortly thereafter, the ETF redeems the AP’s shares by distributing securities contributed by the investor. Once the steps are complete, the ETF holds a portfolio materially different from the investor’s contribution.
Applying substance-over-form and step-transaction principles, the IRS treats the ETF as a conduit for securities transferred from the investor to the AP. It holds that the investor has a taxable exchange under Section 1001 with the AP of the securities contributed to the ETF and used to redeem the AP. The ruling says the result is the same if multiple investors participate. The holding is tied to the described facts; it is not a ruling that every contribution followed by an in-kind redemption has the same tax treatment.
Questions the ruling leaves open
The ruling does not give a complete method for identifying which securities are treated as exchanged or how to represent deemed consideration while preserving the parties’ actual legal and economic relationships. It also does not resolve the resulting basis, holding-period, gain, Section 351 diversification, or regulated investment company (RIC) consequences.
Its references to a common “plan,” steps occurring “shortly thereafter,” and a “materially different” portfolio also leave fact-specific questions. In its October 6, 2026 practitioner analysis, Morgan Lewis observes that the ruling supplies no comprehensive factor test for determining whether a plan exists and that “materially different” is uncertain in this context. Those are practitioner observations, not additional IRS holdings.
Potential effect on earlier transactions
Morgan Lewis notes that the ruling does not invoke Section 7805(b) to limit retroactive effect and could therefore be used to challenge prior similar transactions. The IRS describes a revenue ruling as applying existing law to the facts it states. The ruling does not establish that every earlier or differently structured transaction is covered; the relevant facts and existing law matter. Morgan Lewis also flags potential accuracy-related penalty and disclosure questions for positions contrary to the ruling.
What Notice 2026-62 is—and is not—doing
Notice 2026-62, also dated September 28, 2026, is a request for information and comments, not a final regulation resolving each strategy it describes. Treasury and the IRS are considering further regulations, notices, revenue rulings, or other published guidance, potentially including identification of a transaction of interest or listed transaction. The Notice also says the IRS may challenge a strategy on examination under existing law. Any future guidance could be prospective or retroactive; the Notice does not establish what guidance will issue or how it will apply.
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The Notice describes five ETF strategy categories and three categories involving tax-aware funds or separately managed accounts. Its descriptions identify transactions for government scrutiny; they do not establish how common those transactions are or determine the tax result for every variation.
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Section 351 conversion transactions
The Notice describes planned contributions of appreciated securities to a newly formed ETF, followed by AP creations and redemptions that distribute some of those contributed securities. The intended result is exposure to a materially different portfolio without immediate recognition of built-in gains. The Notice expressly excludes from its view a seed of a new ETF with assets consistent with its investment thesis that are intended and expected to remain in the fund absent a substantial change in circumstances.
Partnership or exchange-fund variation
In this example, investors contribute appreciated securities to a partnership that holds at least 20% of its assets outside stocks or securities. The partnership contributes a diversified pool of stocks and securities to an ETF, followed by an in-kind AP redemption. The Notice characterizes the described structure as combining Sections 351, 721, and 852(b)(6) to produce a result it regards as unintended. The 20% figure is part of this example’s facts, not a general exchange-fund threshold or recommendation.
Box-spread funds
The Notice discusses ETFs using four options on the same underlying property to generate a stable return based on the time value of money, then distributing appreciated options through in-kind redemptions before expiration. It describes the claimed effect as avoiding current fund-level income or gain and distributions. It also discusses a variant involving an offsetting straddle. The options in the described transactions are not Section 1256 contracts.
Record-date or dividend-avoidance strategies
The Notice describes an upper-tier equity ETF distributing shares of an underlying index ETF shortly before its dividend record date, then replacing them with a different ETF tracking the same index but having a different record date. The claimed aim is to preserve similar exposure while avoiding current dividend income. The Notice says similar strategies may involve bond ETFs.
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A RIC generally must meet a 90% gross-income requirement under Section 851(b)(2). The Notice describes an ETF holding assets that generate income generally not qualifying for that test, such as commodities or digital assets, or grantor trusts holding them. The fund distributes assets in kind to an AP and takes the position that it does not recognize gain for purposes of the income test. The Notice identifies this position for scrutiny; it does not establish that every fund holding such assets or making an in-kind distribution fails the test.
Tax-aware fund and separately managed account strategies
Identified straddles used to convert character
The Notice’s example pairs a foreign-currency forward governed by Section 988 with a Section 1256 futures contract on the same currency. It describes sequencing and loss-capitalization positions claimed to produce capital gain alongside ordinary loss or to reduce ordinary income. It also mentions a variation involving an equity-index swap and futures.
Same-day foreign currency forward acquisitions and dispositions
The Notice describes funds acquiring and disposing of forwards on the same day, then making a Section 988(a)(1)(B) election before day-end when the contract’s result is known. The concern it identifies is selective character treatment between winning and losing positions.
Selective swap terminations
In the described approach, a fund terminates appreciated swaps shortly before contingent payments, claiming capital gain under Section 1234A, while holding depreciated swaps through payment and claiming ordinary expense. The stated objective is to generate capital gains and ordinary losses.
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How to distinguish the described transactions from ordinary activity
The Notice recognizes regular ETF creations and redemptions and says it does not express a view on ordinary-course distributions except for the strategies it discusses. Treasury and the IRS say they intend to target specific abusive transactions, minimize compliance burdens, and respect conventional, long-established tax planning consistent with congressional intent. That statement is an agency intention, not a detailed safe harbor for every transaction outside the examples.
For a transaction that appears similar to an example, relevant distinctions may include:
- Whether the contribution, creation, and redemption were steps in a plan, rather than independent ordinary-course events.
- How much time passed between the steps and whether contributed assets were consistent with the ETF’s investment thesis and expected to remain in the fund.
- Whether the transaction materially changed the investor’s economic exposure or left the ETF with a materially different portfolio.
- For tax-aware fund transactions, which instruments and character rules apply, when elections or payments occurred, and whether the position selected gain or loss character after outcomes were known.
- Whether facts or economics differ from the specific examples in the Notice.
The IRS ruling’s fact pattern and the Notice’s examples are not substitutes for analyzing the particular transaction, its documentation, and applicable law.
What affected funds, investors, and advisers can do now
The Notice asks whether its transaction descriptions are accurate, whether other facts matter, whether apparently similar transactions differ in facts or economics in ways that warrant different federal income tax treatment, and what guidance would preserve well-established market practice consistent with congressional intent. Comments are requested by October 28, 2026.
Morgan Lewis recommends that affected funds, sponsors, investors, and advisers identify past and planned transactions, assess exposure under existing law, consider disclosure and penalty questions, preserve evidence of non-tax business purposes, and consider submitting comments. These are practitioner recommendations, not IRS requirements. For a specific transaction, tax advisers can assess how the documents, timing, economic effects, and tax positions compare with the ruling and Notice.
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