IRS Guidance on Investment Fund Tax Strategies: Notice 2026-62 and Revenue Ruling 2026-20

The U.S. Department of the Treasury (the Treasury Department) and the Internal Revenue Service (the IRS) on September 28, 2026, issued Notice 2026-62 (the Notice), identifying novel investment fund strategies that purport to produce tax results inconsistent with the purpose and proper application of the Internal Revenue Code of 1986, as amended (the Code) and other applicable guidance.¹ According to the Notice, the strategies identified are undertaken by investment funds to avoid or defer taxable income that would otherwise be recognized by the funds or passed through to their investors. Concurrently, the Treasury Department and the IRS issued Revenue Ruling 2026-20 (the Revenue Ruling), addressing one specific strategy described in the Notice that relates to the so-called “section 351 conversion transactions.”²

Revenue Ruling 2026-20

The Revenue Ruling addresses whether a transfer of securities to a newly formed exchange-traded fund (ETF) intended to qualify under section 351 fails to qualify if, as part of the same plan, some or all of the transferred securities are distributed under section 852(b)(6) in redemption of shares held by an authorized participant.

In the facts of the Revenue Ruling, as part of a plan an investor transfers a portfolio of securities to a newly formed ETF. At the time of the transfer, the investor’s securities are appreciated, and the transferred portfolio is diversified. Pursuant to the same plan, the ETF issues shares to a person serving as an authorized participant in exchange for securities that are consistent with the ETF’s investment thesis (or cash that the ETF intends to use to acquire such securities); and shortly thereafter, the ETF redeems those shares in exchange for securities transferred to the ETF by the investor. Upon completion of the planned transactions, the ETF holds a portfolio of securities consistent with its investment thesis and materially different from the portfolio transferred by the investor.

The Revenue Ruling holds that the transfer is recharacterized to reflect the substance of the plan: the investor is treated as engaging in a taxable exchange with the authorized participant of the investor’s portfolio for shares of the ETF, rather than a tax-deferred section 351 contribution; the result is the same where multiple investors are involved. The Revenue Ruling is the Treasury Department and the IRS’s application of law and could be applied to contributions made before its publication.

Notice 2026-62

The Notice identifies certain “novel” investment fund strategies that purport to produce tax results that may be inconsistent with the purpose and proper application of the relevant federal tax rules, and that are not the product of conventional, long-established tax planning consistent with congressional intent. The Treasury Department and the IRS are considering issuing guidance to address these transactions, including the potential identification of a transaction as a transaction of interest or listed transaction requiring tax shelter disclosure.

The Notice requests comments and information on the described transactions and similar transactions by October 28, 2026. Impacted investment managers should consider commenting, either directly or through an industry group.

The strategies identified in the Notice are of two categories: the first category involves “atypical” usage by an ETF of section 852(b)(6); and the second category includes certain strategies used by “tax-aware” strategies to create a pattern of generating capital gain and ordinary loss.

ETF strategies

The Notice describes certain strategies that the Treasury Department and the IRS believe rely on distributions of appreciated property subject to section 852(b)(6) (alone or together with other tax rules) not simply to operate an ETF in the ordinary course of carrying out its investment strategy, but to avoid income or gain inclusion for its shareholders in a manner that is not consistent with the intent of Congress.

The ETFs addressed by the Notice are regulated investment companies (RICs) for U.S. federal income tax purposes. As background, section 852(b)(6) allows a RIC to distribute appreciated property to redeeming shareholders without the RIC recognizing the unrealized appreciation in such property. ETFs regularly engage in creation (i.e., the process of issuing units of ETF shares) and redemption transactions with licensed broker-dealers that are commonly known as “authorized participants.”

• Section 351 conversion transactions. The Notice outlines facts similar to those provided in the Revenue Ruling, highlighting a concern where some or all of the securities in the transferred portfolio do not align with, or are overweighted as compared to, the ETF’s contemplated portfolio or investment strategy. The Notice explicitly does not address, and expresses no view regarding, transactions in which a section 351 transaction is used to seed a newly established ETF with assets that are consistent with the ETF’s investment thesis and that are intended and expected to be retained by the ETF absent a substantial change in circumstances (including an unexpected change in market or business conditions).
• Partnership exchange funds. The Treasury Department and the IRS describe a transaction in which investors contribute their undiversified, appreciated securities to a partnership. The partnership invests at least 20 percent of the value of its assets in assets that are not securities, such that if the partnership were instead a corporation it would not be treated as an “investment company” for tax purposes. As such, the contributors treat the contribution as a nonrecognition contribution under section 721. The partnership then carries out a section 351 transaction in the manner described above. Other than as described in the Notice, no view is being expressed regarding other transactions involving exchange funds.
• Box spread funds. The Treasury Department and the IRS expressed concern that some ETFs are taking the position that section 852(b)(6) applies to a redemption transaction that occurs as part of a strategy that involves box spreads to provide the type of stable time-value-of-money return ordinarily associated with investment in government obligations without current income recognition. Used in this context, a “box spread” is a combination of four options on the same underlying asset that together produce a stable time-value-of-money return similar to a short-term interest rate. The Notice describes an ETF that enters into box spreads that consist of options that are not section 1256 contracts and later distributes the appreciated options to redeeming authorized participants in a redemption transaction intended to qualify for nonrecognition under section 852(b)(6). As described in the Notice, such ETF avoids recognizing income or gain from the box spreads, and shareholders of such ETF recognize capital gain based on their holding periods when they sell the ETF shares. The Notice also describes an ETF that engages in box spread transactions and separately enters into offsetting positions that constitute a straddle within the meaning of section 1092(c)(1).
• Other ETF strategies discussed. The Notice describes two other strategies. First, the Notice describes a situation in which an ETF (the parent ETF) invests in other ETFs (the acquired ETFs) that provide exposure to the underlying index or asset class sought after by the parent ETF and disposes of the acquired ETF shortly before a scheduled record date to acquire another ETF tracking the same index. The Notice also discusses an ETF that holds assets that are not RIC-qualifying sources of income (such as commodities or digital assets) and intends to avoid recognizing the gain on such assets by distributing such assets to redeeming authorized participants through a nonrecognition redemption under section 852(b)(6).

“Tax-aware” fund strategies

The Notice addresses three strategies it views as more frequently used in private funds treated as partnerships or in separately managed accounts.

• Identified straddles with mixed character. The Treasury Department and the IRS address a strategy that involves the investor acquiring both positions that produce capital gain or loss and offsetting positions that produce ordinary gain or loss and making a straddle identification under section 1092(a)(2) (an identified straddle). The Notice expresses concern that the electivity of character of gains and losses within this strategy is not consistent with congressional intent.
• Same-day trading of foreign currency forward contracts. By default, gains and losses on foreign currency forward contracts are ordinary in character. Section 988(a)(1)(B) allows a taxpayer to elect, on a contract-by-contract basis, to treat such gains and losses as capital instead, provided that the election is made by the close of the day on which the contract is entered into and the transaction otherwise qualifies for the election. The Notice expresses concerns about situations in which a foreign currency forward contract is entered into and closed out on the same day, with the tax election being made at the close of the day only on contracts on which a loss is recognized.
• Selective NPC terminations. The Notice identifies a concern about the use of multiple swaps that are notional principal contracts (NPCs) for federal income tax purposes. Each NPC provides for one or more periodic or nonperiodic payments, and one or more of these payments is contingent on the performance of an underlying asset such as stock. The Notice expresses concern that the strategy uses selectivity to achieve different character of similar payments on identical financial instruments, contrary to the timing and character rules applicable to such NPCs.
  

Footnotes

1. I.R.S. Notice 2026-62. Unless otherwise provided, all references to sections or subchapters herein are to sections or subchapters of the Code.
2. Rev. Rul. 2026-20.