The US Treasury and Internal Revenue Service have issued new guidance restricting how wealthy investors use exchange-traded funds to defer capital gains taxes, CNBC reported on Friday. The crackdown targets certain uses of Section 351 exchanges, in which individuals create new ETFs with baskets of highly appreciated stocks to avoid immediate tax on gains.
Treasury Secretary Scott Bessent said in a post on X that the guidance makes clear the government is serious about cracking down on transactions designed to dodge taxes or exploit the federal tax code. He added that the message on these conversions is clear: they do not work under existing law. The IRS revenue ruling addresses instances where an ETF is merely a conduit for transferring securities to avoid taxes, and where investors end up with a materially different portfolio without recognising built-in gains.
A Bloomberg analysis from July found that 22 billion dollars in ETFs had been created for this purpose, deferring as much as 6.5 billion dollars in capital gains, with activity accelerating significantly since 2024. Creating an ETF can cost 200,000 to 300,000 dollars, and some firms suggest investors should have at least 25 million dollars of appreciated stocks for the strategy to be viable, though one Boston-based managing partner sets the threshold at 100 million dollars.
The notice does not imply all Section 351 transactions are suspect. Tax authorities stated they are not addressing transactions in which a Section 351 exchange is used to seed a newly established ETF with assets consistent with the ETF's investment thesis and intended to be retained absent a substantial change in circumstances. Valid reasons for high-net-worth individuals to use the strategy include gifting ETF shares to individuals who do not want individual stock shares, or converting separately managed accounts into ETFs to lessen ongoing tax burdens.
The IRS made clear that transactions occurring shortly after appreciated securities are contributed are suspect, but did not elaborate on the timeframe. Tax practitioners and legal professionals expect further guidance on what constitutes "shortly thereafter". The IRS and Treasury are requesting comments on the notice by 28 October.
Why it matters for wealth
This guidance directly affects tax-deferral strategies used by investors with portfolios exceeding 25 million dollars. The lack of clarity on timing creates uncertainty for wealth advisors structuring ETF conversions, and further IRS guidance will determine which existing structures remain compliant.
What to watch
The IRS comment period closes on 28 October, after which tax authorities are expected to release additional guidance clarifying what timeframes and portfolio changes trigger the new restrictions.
Source: CNBC
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