IRS Issued Guidance on ETF Conversions

New tax rules target specific Section 351 strategies used by exchange-traded funds.

Updated on Oct. 14, 2026 in Investing

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The Internal Revenue Service released Notice 2026-62 and Revenue Ruling 2026-20 to address Section 351 ETF conversions. The new guidance focuses on arrangements that function as conduits for tax avoidance.

Why it matters

The IRS aims to curb tax-deferral strategies that lack a legitimate investment thesis. By recharacterizing certain deals as taxable exchanges, the agency intends to ensure funds possess diversified portfolios rather than concentrated, non-fitting assets.

Section 351 ETFs account for over $40 billion in assets under management across more than 100 funds seeded since 2021. The IRS mandate now recharacterizes transactions as taxable exchanges when funds fail to maintain diversified holdings.

The players

Internal Revenue Service

The Internal Revenue Service is the primary federal agency responsible for tax collection and the enforcement of tax law in the United States.

The details

The IRS guidance targets specific box spread ETFs and Section 351 conversions where an ETF issues shares to an authorized participant for matching securities and then quickly redeems them for non-fitting assets. Firms are currently working to demonstrate that their existing deals are legitimate and support an underlying investment thesis.

More than 100 ETFs have been seeded using Section 351 since 2021.
The IRS issued Notice 2026-62 and Rev. Rul. 2026-20 on September 28, 2026.

Market Dynamics

This regulatory shift reflects an increasing focus by tax authorities on closing loopholes within Section 351 of the Internal Revenue Code. The guidance follows a period of rapid industry growth and signals a stricter compliance environment for fund managers.

Retail investors holding ETFs involved in these specific conversion strategies may face changes in the tax treatment of their fund distributions. Investors should consult with a financial advisor to understand if their holdings are impacted by these recharacterized tax arrangements.

The takeaway

The IRS is increasing scrutiny on investment products that appear designed solely for tax advantages. Investors should prioritize funds that demonstrate a clear, long-term strategy rather than those relying on complex conversion tactics.