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Outbyte PC Repair FREEClear out junk files and repair common Windows errorsFree Scan →Outbyte Driver Updater FREEFix the driver behind crashes, sound loss and screen glitchesFind Drivers →The IRS has rejected a specific planned transaction that lets an investor contribute appreciated securities to a newly formed exchange-traded fund (ETF), receive an interest in a different portfolio, and attempt to defer the built-in gain. Notice 2026-62 and Revenue Ruling 2026-20, issued September 28, 2026, say the investor’s contribution in the covered pattern is taxable under Section 1001 rather than a nonrecognition contribution under Section 351. The government has not said that every Section 351 ETF seed is prohibited. Its notice expressly preserves ordinary seeding of a new ETF with assets that fit the fund’s investment thesis and are expected to remain there.
What the 351 ETF controversy is about
A Section 351 ETF conversion is a proposed way to move appreciated securities into an ETF without immediately recognizing the unrealized gain. In the transaction pattern described by the Treasury Department and the IRS, an investor contributes appreciated securities to a newly formed ETF. An authorized participant (AP) then contributes securities that match the ETF’s investment strategy, receives ETF creation units, and redeems those units for the investor’s original securities. The investor is left holding an ETF interest backed by a materially different portfolio, while the original contribution is presented as a tax-deferred Section 351 exchange.
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That sequence matters because each step can look familiar when viewed alone. Section 351 generally provides nonrecognition when property is transferred to a corporation for stock and the transferors control the corporation immediately after the exchange. ETF creation and redemption are also ordinary operating mechanisms. The IRS says the covered transactions must instead be evaluated as a planned whole: the contribution, creation and redemption were arranged to exchange the investor’s securities for exposure to a different portfolio while avoiding current gain.
Revenue Ruling 2026-20 concludes that, on those facts, the investor’s transfer is properly treated as a taxable exchange with the AP under Section 1001. The notice says the structure combines Section 351 with Section 852(b)(6), the rule that can allow a regulated investment company to distribute appreciated property in certain redemptions, to obtain a result neither provision was designed to produce.
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This is a ruling about the transaction pattern addressed in the ruling. It is not a blanket finding that every contribution of securities to an ETF under Section 351 fails, and it is not a final answer for every legitimate fund launch.
How the planned transaction works
1. An investor starts with appreciated securities
The investor owns stocks or other securities with a fair-market value above tax basis. Selling them directly would normally trigger gain under Section 1001. The proposed conversion is aimed at changing the investor’s portfolio without that immediate sale.
2. A new ETF is organized
The ETF is formed with an investment thesis—for example, a defined asset allocation, sector exposure or other stated strategy. The fund needs assets so that creation units can be issued to an AP.
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The investor transfers the appreciated securities to the ETF and receives an ETF interest. The transaction is characterized as a Section 351 contribution, so the built-in gain is not recognized at that moment under the intended treatment.
4. The AP contributes strategy-aligned securities
As part of the same plan, the AP contributes securities that fit the ETF’s investment thesis. In return, the AP receives creation units—the large blocks of ETF shares used in the primary-market creation process.
5. The AP redeems for the investor’s original securities
The AP then redeems the creation units and receives the securities the investor originally contributed. The investor retains an ETF interest representing a materially different portfolio. The planned exchange, rather than an incidental later portfolio change, is the feature that draws the IRS’s attention.
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What Notice 2026-62 and Revenue Ruling 2026-20 say
Notice 2026-62 is the Treasury Department and IRS announcement accompanying Revenue Ruling 2026-20. The notice says the government is addressing so-called “§ 351 conversion transactions” promoted as a way to diversify without recognizing built-in gains. For the described facts, the investor’s contribution is treated as a taxable exchange with the AP under Section 1001, not as a contribution qualifying for Section 351.
The government’s analysis looks to the planned steps together. A formal transfer of property to a fund cannot be isolated from a prearranged creation-and-redemption sequence if that sequence is what changes the investor’s portfolio. The ruling therefore focuses on substance and the integrated plan rather than on whether each document, transfer or redemption is separately authorized by an ETF rule.
The official notice states: “The Treasury Department and the IRS are considering additional guidance to address § 351 conversion transactions.” That sentence signals that the September 28 release is not necessarily the end of the policy discussion. It also means reporting and implementation details could change as comments are reviewed and further guidance is issued.
What the IRS has not prohibited
The notice contains an important limitation. It does not address, and expresses no view regarding, a Section 351 transaction used to seed a newly established ETF with assets consistent with the ETF’s investment thesis and intended to be retained in the fund absent a substantial change in circumstances.
That distinction separates ordinary ETF seeding from the conversion pattern:
| Feature | Planned conversion pattern addressed in Revenue Ruling 2026-20 | Ordinary seeding expressly left open by Notice 2026-62 |
|---|---|---|
| Portfolio contributed by investor | Appreciated securities are contributed with a later exchange for different exposure planned. | Assets are consistent with the new ETF’s stated investment thesis. |
| Creation and redemption | An AP is expected to contribute aligned securities, receive creation units and redeem for the investor’s original holdings as part of the plan. | No prearranged redemption or portfolio swap is described. |
| Expected holding period | The contributed securities are not intended to remain the fund’s portfolio after the planned steps. | Assets are intended to remain in the fund unless circumstances materially change. |
| Government position | Covered contribution is treated as a taxable Section 1001 exchange with the AP. | The notice expresses no view on this fact pattern. |
The table reflects the distinctions in the notice, not a substitute for applying the tax law to a particular fund’s documents and conduct. A transaction that falls between the examples requires a fact-specific analysis.
Why Sections 351 and 852(b)(6) matter
Section 351
Section 351 is a nonrecognition provision. In a qualifying transfer, property can be exchanged for an interest in a corporation without immediate gain recognition, subject to statutory requirements and exceptions. The strategy relied on that general framework to treat the investor’s delivery of appreciated securities as a contribution rather than a sale.
For a fund sponsor or investor, the critical questions are not simply whether securities changed hands or whether ETF shares were issued. They include who transferred what, what ownership and control existed immediately after the transfer, and whether the documents and surrounding arrangements show that the transfer was part of an exchange for different property.
Section 852(b)(6)
Section 852(b)(6) can allow a regulated investment company to distribute appreciated securities in certain redemptions without recognizing the gain at the fund level. That rule is useful in normal ETF operations because in-kind redemptions can help a fund manage its tax exposure.
The IRS says the conversion arrangement combined that redemption rule with Section 351 to manufacture a portfolio change without the investor recognizing gain. Its conclusion is that the combined steps cannot be used to obtain the intended nonrecognition result on the facts addressed by the ruling.
Who is affected and what changes now
Individual investors
An investor considering a 351 conversion should not assume that receiving ETF shares means the gain has disappeared. Under the ruling’s covered pattern, the contribution is treated as a taxable exchange. The investor may therefore face current gain, basis and holding-period consequences, and reporting obligations that differ from the proposed nonrecognition treatment.
The practical question is whether the actual transaction documents, timing, communications and portfolio choices resemble the planned conversion described by the IRS. A tax professional should review those facts before a transfer is made; the answer cannot be determined from the fund’s label alone.
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ETF sponsors and organizers
Sponsors need to examine the relationship among the fund’s investment thesis, the assets accepted at launch, AP arrangements, redemption mechanics and any expected portfolio replacement. Marketing that promises diversification of appreciated holdings without current tax could attract scrutiny if the promised result depends on prearranged steps of the kind described in the ruling.
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Authorized participants and intermediaries
APs are central to the transaction because they contribute securities, receive creation units and carry out the redemption. Their agreements, instructions and communications may help establish whether a later exchange was contemplated from the beginning. Operational separation on paper does not necessarily change the tax analysis if the steps were coordinated as one plan.
Tax advisers and custodians
Advisers should preserve the fund’s launch documents, contribution records, AP agreements, trade instructions and client communications. Those records can show whether assets were intended to remain in the fund or whether a replacement transaction was expected. Custodians and administrators may need to confirm how a taxable exchange is reflected on statements and information reporting.
How to evaluate a proposed 351 ETF transaction
The following checklist organizes the factual questions highlighted by the notice. It is not a legal safe harbor.
- Match the assets to the thesis. Do the securities being contributed genuinely fit the ETF’s stated investment strategy, or were they selected mainly because they are appreciated and available to be exchanged?
- Document the expected destination. Are the contributed securities intended to remain in the fund absent a substantial change in circumstances? If not, identify what replacement was contemplated and when.
- Map every participant. List the investor, ETF, sponsor, AP, custodian and other intermediaries, and describe what each contributes and receives.
- Review the sequence as one plan. Compare formation documents, contribution agreements, AP contracts, trade instructions and communications. Look for a prearranged creation followed by redemption for the investor’s original securities.
- Test the actual tax result. Determine whether Section 1001 gain recognition, basis adjustments, holding periods and information reporting apply if the transaction is treated as the ruling describes.
- Check the date and guidance in force. Notice 2026-62 is dated September 28, 2026. PwC’s October 6, 2026 summary reported an October 28, 2026 comment deadline. Because Treasury and the IRS said additional guidance was under consideration, verify the current deadline and any subsequent release before acting.
- Obtain written advice. Use a tax attorney or CPA experienced with investment funds and regulated investment companies. A generic return preparer may not be equipped to analyze an integrated ETF transaction.
Common misunderstandings
“The IRS banned Section 351 ETF contributions.”
That is too broad. The government addressed a planned contribution-and-redemption pattern and expressly left ordinary seeding with thesis-consistent assets outside the notice’s scope.
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“A redemption is always taxable.”
The issue is not that every ETF redemption is invalid. The notice focuses on a redemption that was part of a coordinated plan to return the investor’s original securities while changing the investor’s exposure.
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“The ETF’s legal form decides the result.”
Calling an arrangement a fund contribution, creation or redemption does not settle whether the integrated steps are a taxable exchange. The ruling examines what the parties planned to accomplish.
“The September release is the final word.”
Notice 2026-62 says Treasury and the IRS are considering additional guidance. Later guidance may clarify effective dates, reporting and the boundary between conversion transactions and ordinary seeding.
Timing and status as of October 18, 2026
Notice 2026-62 and Revenue Ruling 2026-20 were issued together on September 28, 2026. PwC reported October 28, 2026 as the deadline for comments. On October 18, 2026, that deadline was still in the future, but the status of any extension or later guidance must be checked directly with Treasury or the IRS.
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The ETF Prime summary published October 7, 2026 identified the warning as the episode’s lead subject and listed host Nate Geraci, Cinthia Murphy of TMX VettaFi and Jeff Klingelhofer of Aristotle Pacific among the participants. The short summary does not establish the guests’ individual arguments or quotations, so those should not be attributed without consulting the full episode.
What investors should do next
- Pause any planned transfer marketed as a tax-free way to swap appreciated securities for a different ETF portfolio.
- Ask for a written description of every planned contribution, creation and redemption step, including the AP’s role.
- Compare the contributed assets with the ETF’s investment thesis and document whether they are expected to remain in the fund.
- Have an investment-fund tax specialist model the result if the IRS treats the steps as a Section 1001 exchange.
- Recheck official guidance and the comment status before relying on a structure that was designed before September 28, 2026.
The central lesson is narrow but consequential: a Section 351 label does not control when a contribution and an ETF creation-and-redemption sequence were planned together to deliver different portfolio exposure. At the same time, the IRS notice preserves room for conventional ETF seeding, so the government’s scrutiny should not be described as a prohibition on every Section 351 contribution.
Frequently Asked Questions
Does Notice 2026-62 make all ETF contributions of appreciated securities taxable?
No. The notice addresses the planned conversion pattern described in Revenue Ruling 2026-20 and expressly says it does not address seeding a new ETF with assets consistent with the fund’s investment thesis and intended to remain there absent a substantial change.
What is the key fact that distinguishes an ordinary seed from a conversion transaction?
The key distinction is whether the contribution, AP creation and redemption were planned together to replace the investor’s securities with materially different portfolio exposure. The notice also considers whether the contributed assets match the ETF’s thesis and are intended to stay in the fund.
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Notice 2026-62 is dated September 28, 2026. PwC’s October 6, 2026 summary reported October 28, 2026 as the comment deadline.
Should an investor rely on the proposed nonrecognition treatment without professional advice?
No. The tax result depends on the complete facts, documents and timing. A tax attorney or CPA experienced with investment funds should analyze the arrangement before any securities are transferred.
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