Crypto exchange-traded funds (ETFs) have been placed on notice by the IRS. A directive released on Monday highlights funds holding digital assets that utilize a trading mechanism to avoid recording gains on their books.
On the exact same day, the IRS terminated a tax-free stock swap utilized by affluent investors. Both regulatory actions focus on the identical ETF regulation.
How Crypto ETFs Keep Gains Off the Books
The majority of U.S. funds enjoy a specialized tax classification. They are exempt from corporate taxation themselves, provided that a minimum of 90% of their revenue stems from dividends, interest, and stock appreciation.
Profits generated from commodities and cryptocurrencies do not qualify toward this threshold. Generating an excessive amount of this specific income jeopardizes the tax exemption.
According to the IRS, certain ETFs discovered a workaround. They transfer appreciating digital assets to Wall Street trading firms that redeem fund shares. An existing rule permits ETFs to execute these transfers without logging a taxable gain.
Failing to book a gain prevents the accumulation of disqualifying income. The notice specifies that this mechanism functions whether the fund holds the assets directly or via a trust structure.
Which Crypto Funds Are at Risk
Specific funds are not identified in the notice. Spot Bitcoin ETFs, such as BlackRock’s Bitcoin ETF, are structured differently. SEC filings indicate that the iShares Bitcoin Trust operates as a grantor trust, transferring its tax characteristics directly to shareholders.
The vulnerability rests with standard funds holding cryptocurrency or shares of such trusts. Conversely, funds that maintain these assets through an offshore subsidiary are exempt from the scope of the notice.
The IRS cautioned that any eventual regulatory correction could be applied retroactively.
“Any such guidance could apply prospectively only or retroactively to transactions that already have taken place…”
Public comments must be submitted by October 28.
The IRS Also Shut a Tax-Free Stock Swap
The warning accompanied Revenue Ruling 2026-20, which invalidates the Section 351 conversion. This strategy previously allowed wealthy investors to exchange highly appreciated stock for a diversified fund without triggering taxes.
“Sounds like it’s just cracking down on ones that break from spirit of law,” noted Eric Balchunas, an ETF expert.
Under the arrangement, an investor contributed assets to a newly established ETF, which subsequently transferred the stock to a trading firm. The IRS now classifies this transaction as a taxable sale.
Ed Zollars, a CPA who authors Current Federal Tax Developments, advised financial practitioners to audit past client conversions.
The Investment Company Institute (ICI), the primary trade association for U.S. funds, informed the Treasury department that these conversions provide portfolio diversification and reduced fees, as reported by the law firm Liskow.
Frequently Asked Questions
When is the deadline for public comments on the IRS notice?
Public comments regarding the IRS notice are due by October 28.
What revenue ruling accompanied the IRS warning?
The warning was accompanied by Revenue Ruling 2026-20, which shuts down the Section 351 stock conversion strategy.
Are spot Bitcoin ETFs like BlackRock’s affected by the notice?
Spot Bitcoin ETFs such as BlackRock’s are structured differently; the iShares Bitcoin Trust is a grantor trust that passes its tax attributes directly to shareholders according to its SEC filings.
Which crypto funds face risk under the new IRS notice?
The exposure applies to standard funds holding crypto or shares of such trusts, though funds holding these assets via an offshore subsidiary are exempt.
