On September 28, 2026, Treasury and the IRS issued Revenue Ruling 2026-20 and Notice 2026-62. Together they address Section 351/ETF conversions, ETFs’ use of in-kind redemptions to avoid income and non-qualifying income recognition, and investment funds’ strained reading of technical rules to generate taxpayer-favorable capital gains and ordinary losses.

Michael Scott once shouted “I declare bankruptcy!” and assumed that his words controlled. Some advisors took a similar approach to Section 351/ETF conversion structures. The IRS has now made clear that announcing a structure qualifies for nonrecognition treatment does not make it so.

If you don’t want to read, but would rather bang on a mug all day, the list below provides the key issues to note from the ruling and notice:

  • ETF redemption strategies. Funds that have used Section 351/ETF conversions, box spreads, record date trades, or other techniques described in Notice 2026-62 should consult tax counsel. Rev. Rul. 2026-20 treats the Section 351/ETF conversion as taxable today.
  • Tax-aware funds. Managers and investors in funds that use currency straddles, same-day elections, or selective swap terminations should expect IRS scrutiny. 
  • Investor-facing materials. Review offering materials, pitch decks, and investor letters that explain the potential tax benefits from the Section 351/ETF conversion, box spread, record date trade, and other named strategies.  Such materials may need to be revised to add caveats or disclosures about Notice 2026-62 and/or Rev. Rul. 2026-20.
  • What is and is not targeted. Normal ETF activity is outside the Notice’s scope.  Routine end-of-year tax-loss harvesting, seeding a new ETF with assets that fit its investment thesis, and other ordinary ETF creation and redemption transactions likely will not be affected. But Treasury is warning taxpayers and advisors that there is a line between abusive and acceptable tax planning strategies. 

For those that downloaded, but have not yet read, the ruling or notice, the below expanded discussion is for you.

Link to What the IRS said in Revenue Ruling 2026-20 What the IRS said in Revenue Ruling 2026-20

The ruling addresses a specific sequence of transactions. First, an investor transfers a diversified portfolio of appreciated securities to a newly formed ETF. As part of the same plan, the ETF issues shares to an “authorized participant” (AP) in exchange for securities that fit the ETF’s investment thesis, or for cash to buy such securities. Shortly afterward, the ETF redeems the AP’s shares in exchange for the investor’s securities. At the end, the ETF holds a portfolio that is “materially different” from what the investor contributed but consistent with its investment thesis.

Applying the substance-over-form and step-transaction doctrines, the IRS treated the ETF as “merely a conduit” through which the investor transferred securities to the AP in a taxable exchange. The holding is that the transaction should be recharacterized to treat the investor as undertaking a taxable exchange under Section 1001 with the AP of the securities contributed to the ETF. The ruling also notes that the result is the same where multiple investors participate in the transaction.

The ruling leaves two practical questions open. It gives no specific guidance on when a contribution and a later redemption are “part of the same plan,” or on what makes two portfolios “materially different”. It also does not say clearly what the investor is treated as receiving in the deemed exchange.

Link to What the IRS said in Notice 2026-62 What the IRS said in Notice 2026-62

The Notice goes well beyond the ruling’s single transaction. It describes “novel investment fund strategies” that may be inconsistent with the purpose of the relevant tax rules, and it asks for written comments by October 28, 2026. The strategies identified in Notice 2026-62 include:

  • Partnership variation: Investors holding non-diversified securities first contribute the securities to a partnership that invests at least 20% of its assets in non-stock/securities property. That contribution is intended to be tax free under Section 721.  The partnership then carries out the Section 351/ETF conversion described in Rev. Rul. 2026-20. Treasury is considering guidance that would deny nonrecognition treatment for these partnership contributions.

  • Box spread funds: These ETFs produce a return akin to an investment in government obligations (e.g., Treasury notes/bonds) without current income recognition by distributing the appreciated option legs in redemption of creation units.  That distribution is intended to qualify for nonrecognition under Section 852(b)(6).  The ETF purportedly avoids recognition of income/gain from the box spread and the investor purportedly recognizes no current income while receiving a return consistent with a short-term interest rate. 

  • Record date strategies: A parent ETF distributes shares of an acquired ETF just before the dividend record date to avoid dividend income at the parent ETF level and avoid recognition of income or capital gain at the investor level until the investor sells their parent ETF shares.  The goal of the transaction is to eliminate taxable dividend income without any material change to the economic characteristics of the assets of the parent ETF.

  • RIC income test avoidance: ETFs holding commodities or digital assets (directly or through a grantor trust) distribute those assets in exchange for creation units so the non-qualifying gains are never recognized nor taken into account for purposes of the RIC income test.

  • “Tax-aware” fund strategies: include Section 1092 mixed-character straddles, same-day Section 988 elections made with hindsight, and swap terminations. These strategies purportedly seek to generate capital gains and ordinary losses.

The most significant development is the warning about future guidance. That guidance may include designating transactions as “listed transactions” or “transactions of interest,” and it could apply retroactively. The IRS also says it may challenge these strategies on examination relying on existing law.

Link to What taxpayers, CPAs, and advisors need to know What taxpayers, CPAs, and advisors need to know

Revenue Ruling 2026-20 is already in effect, and investors who used the conversion strategy described in the ruling may owe tax now. The Notice also cites Treasury’s Section 7805(b) authority to make rules retroactive to prevent abuse. As a result, transactions that have already closed are not safe.

There are limits to the guidance. The Notice expressly does not address using Section 351 to seed a new ETF with assets that fit its investment thesis and are expected to be retained. It also does not address routine ETF creations and redemptions. Treasury acknowledges that conventional tax planning, such as year-end loss harvesting, is consistent with congressional intent, and that calling a fund “tax-aware” is not by itself a cause for concern.

Link to Risk & Documentation Checklist Risk & Documentation Checklist

Key Risks

  • Recharacterization of a completed Section 351 contribution as a taxable exchange under Section 1001.
  • Retroactive guidance or a future listed-transaction or transaction-of-interest designation.
  • Challenges on examination under existing law and judicial doctrines.
  • Marketing claims about tax efficiency that may need to be updated, qualified, or withdrawn.

Documentation Considerations

  • Neither item of guidance imposes a new recordkeeping requirement. However, the IRS’s Section 351/ETF conversion (and partnership variation) analysis turns on whether the steps were part of a “plan” and whether the portfolios are “materially different”. Keep contemporaneous records of the ETF’s investment thesis, how the seed portfolio aligns with it, and why assets are retained.
  • Document any “substantial change in circumstances” behind a post-seeding redemption.
  • Watch for disclosure obligations that would follow if any transaction is designated as a listed transaction or transaction of interest (e.g., Form 8886).

Action Steps

  • Inventory any Section 351 conversions, partnership exchange-fund structures, box spreads, record date trades, and tax-aware fund positions, and consult tax counsel with any questions about the validity of those structures.
  • Review investor communications and marketing materials and update as needed to disclose IRS’s positions as described in Rev. Rul. 2026-20 and Notice 2026-62.
  • Consider submitting comments by October 28, 2026. Comments can be filed at Regulations.gov (IRS-2026-1255) or by mail, and the subject line should reference Notice 2026-62.
  • Monitor future guidance such as regulations and IRS Chief Counsel advice or memorandums, closely.

Link to The Bottom Line The Bottom Line

Treasury has made clear that combining technical rules to produce results Congress never intended will be heavily scrutinized and may not hold up. As Michael Scott learned, saying the words does not make it so. Review your structures now, before the IRS turns your nonrecognition transaction into a taxable event and subjects you to penalties and interest