IRS Narrows Rules on 351 Exchanges, Increasing Compliance Burden

3 hours ago

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Internal Revenue Service. (2026, September 28). Guidance and other actions being considered regarding certain potentially abusive investment fund strategies involving financial products (Notice 2026-62). https://www.irs.gov/pub/irs-drop/n-26-62.pdf

The Treasury Department and the IRS issued Notice 2026-62, identifying novel investment fund strategies that purport to produce tax results that may be inconsistent with the purpose of federal tax rules, alongside companion Revenue Ruling 2026-20 on so-called Section 351 conversion transactions.
In a Section 351 conversion, investors transfer appreciated securities to a newly formed ETF, which issues creation units to an authorized participant and shortly after redeems them with the contributed securities, leaving the ETF with a materially different portfolio.
Revenue Ruling 2026-20 holds that the ETF is merely a conduit in such a plan and treats the investor as making a taxable exchange under Section 1001 of the contributed securities used to redeem the authorized participant.
The notice expresses no view on Section 351 transactions that seed a new ETF with assets consistent with its investment thesis that are intended and expected to be retained absent a substantial change in circumstances.
Other strategies flagged include partnership exchange funds used in connection with Section 351 conversions, box spread funds, record date strategies, RIC income test avoidance, and certain tax-aware fund strategies.
Treasury and the IRS said further guidance could include regulations or identifying a transaction as a transaction of interest or listed transaction, and could apply prospectively or retroactively.
Written comments are requested by October 28, 2026.

Knote: Sounds like the 351 exchange compliance and calculation burden just went up. Technology to the rescue?