The IRS has challenged a specific planned ETF transaction used to defer tax on appreciated securities, but it has not announced a blanket end to ordinary ETF in-kind redemptions. On September 28, 2026, the Treasury Department and IRS issued Notice 2026-62 and Revenue Ruling 2026-20. The ruling treats certain investor contributions followed by related, near-term redemptions as taxable exchanges; the notice asks for input on that and other strategies while distinguishing the arrangement from routine qualifying ETF redemptions.
What did the IRS announce?
The two documents do different jobs. Revenue Ruling 2026-20 addresses a particular described transaction under Internal Revenue Code § 351. Notice 2026-62 describes that and other investment-fund strategies the agencies view as potentially abusive, requests comments and information, and says they may issue further guidance or take other action. The notice also says the government may challenge an abusive transaction under existing law.
The ruling’s conclusion is tied to its described facts: certain investor contributions made as part of a plan involving distribution of some or all of the contributed securities shortly afterward are properly characterized as exchanges under § 1001 between the investors and an authorized participant—not as § 351 contributions to the ETF. It is not a universal ruling on every ETF seed transaction or every use of § 351.
How does the transaction in the ruling work?
- Investors contribute securities that have appreciated in value to a newly formed ETF, seeking to defer recognition of the built-in gain under § 351.
- As part of the plan, an authorized participant contributes securities consistent with the ETF’s investment thesis, or cash intended to buy those securities, and receives ETF creation units.
- The ETF redeems those units by distributing securities contributed by the investors. The ETF is then expected to hold a materially different portfolio aligned with its stated investment thesis.
In the IRS’s analysis, the planned steps mean investors are effectively exchanging their contributed assets for an interest in a materially different ETF portfolio. For the described transaction, the ruling treats the relevant contributions as taxable exchanges with the authorized participant. The sequence, plan, counterparties, assets and resulting portfolio matter; calling a transaction “tax efficient” does not determine its tax treatment.
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How is that different from an ordinary ETF in-kind redemption?
ETF shares trade on an exchange, while authorized participants transact directly with the fund in large creation units. When units are redeemed, the ETF distributes assets with value equal to the redeemed shares’ net asset value; those assets may include appreciated securities. The IRS says qualifying distributions under § 852(b)(6) generally result in nonrecognition of gain or loss for the ETF under §§ 852(b)(6) and 311(a).
The Tax Law Center at NYU Law explains that this mechanism can let standard ETFs avoid recognizing gains on some portfolio trades, with investor-level tax generally deferred until an investor receives a distribution or sells shares. That is not a promise that investors never owe tax.
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| Transaction or strategy | What the September 2026 materials say | Status |
|---|---|---|
| Qualifying ordinary ETF in-kind redemption | The IRS generally recognizes nonrecognition for the ETF under § 852(b)(6); the notice otherwise does not express a view on these ordinary distributions. | Not broadly targeted by the notice’s specific ruling. |
| Described § 351 conversion transaction | Certain planned investor contributions followed by related near-term redemptions are treated as § 1001 taxable exchanges with the authorized participant. | Addressed by Revenue Ruling 2026-20 on its described facts. |
| Partnership variation | Investors contribute built-in-gain securities to a partnership designed to avoid investment-company treatment, which later participates in a § 351 conversion transaction. | The notice says the IRS is considering further guidance; it does not announce a universal ruling covering every exchange fund. |
What other strategies could receive scrutiny?
Notice 2026-62 also discusses box spread funds and record-date strategies. The agencies say they are considering additional guidance or other action, which could include regulations, notices, revenue rulings, or identifying transactions of interest or listed transactions. These are possible next steps, not a statement that every strategy named has already been prohibited.
The notice also does not express a view on using § 351 to seed a newly established ETF with assets consistent with its investment thesis and intended to be retained absent a substantial change in circumstances. That distinction is important: the ruling’s described concern is a planned sequence of contributions and related redemptions, not simply the presence of appreciated assets in a new ETF.
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Why are these strategies attracting attention?
The Tax Law Center’s October 2026 overview reports a Joint Committee on Taxation estimate of at least $205 billion in revenue over a decade associated with this area. The Center says the assumptions behind that estimate are unclear. It is a reported estimate from a secondary analysis—not a calculation stated in Notice 2026-62 or a verified IRS projection.
Independent reader supportYour contribution helps us test, update, and keep practical guides available for everyone.What should investors and advisers examine?
For any transaction involving appreciated securities and an ETF or partnership, the tax analysis should be based on the actual documents and steps, not just the product label or stated objective. Relevant facts include:
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- which assets are contributed and their built-in gains;
- the sequence and timing of contributions, creations and redemptions;
- whether securities contributed by investors are distributed as part of a related plan;
- whether the ETF’s post-transaction portfolio materially differs from the contributed assets and aligns with its investment thesis; and
- the roles of the authorized participant and other parties in arranging or carrying out the steps.
Because the guidance is recent and the outcome depends on transaction-specific facts, investors considering such a structure should consult a qualified tax professional experienced with appreciated securities and ETF or exchange-fund transactions.
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