The IRS has trained its sights on a tax strategy tied to crypto-linked exchange-traded funds, marking an escalation in Washington’s ongoing efforts against structures meant to bypass taxable gains.
According to the Treasury Department and the IRS, digital assets represent an area where fund managers may be stretching tax rules past their original intent, which could lead to tighter regulations or enforcement measures.
Treasury Secretary Scott Bessent took to X to emphasize that the agencies are “serious about cracking down on transactions designed to dodge taxes or exploit our federal tax code,” describing the notice as part of a broader campaign against tax-focused investment vehicles.
This development casts uncertainty over a crypto ETF landscape that spent the prior year embracing the in-kind mechanism traditionally utilized by legacy funds. The Securities and Exchange Commission (SEC) greenlit in-kind creations and redemptions for spot crypto ETFs last year, pointing to potential reductions in costs and price slippage.
While the Treasury refrained from targeting standard ETF redemptions, its focus lies on arrangements that leverage those trades for tax outcomes that regulators believe may not align with a fund’s actual economics.
Crypto enters the IRS crosshairs through a 90% tax test
At the heart of the matter is the regulatory framework governing regulated investment companies (RICs), which encompass a large portion of the US ETF market.
To retain their favorable tax status, RICs generally must pull at least 90% of their annual gross income from permitted sources, including dividends, interest, and gains tied to stocks, securities, and designated currencies.
The Treasury noted that some ETFs contend they can bypass this requirement by entirely omitting gains derived from assets outside of those categories.
The regulatory notice specifically highlights funds holding digital assets or commodities, either directly or via grantor trusts. Rather than liquidating an appreciated holding, a fund can use it to fulfill an in-kind redemption requested by an authorized participant.
Section 852(b)(6) permits ETFs to distribute appreciated property during qualifying redemptions without triggering the embedded gain. Consequently, certain funds argue that this unrecognized gain ought to be left out when calculating compliance with the RIC income test.
The Treasury warned that this approach could let an ETF restrict the income tied to the 90% threshold irrespective of its true economic earnings, expressing clear doubt regarding that legal view.
This stance falls short of a total ban. The government has instead requested feedback on the methodology and is weighing its next steps.
This treatment differs from another tactic caught in the same regulatory sweep. Revenue Ruling 2026-20 explicitly targets prearranged deals where investors deposit appreciated securities into an ETF and promptly pull those assets back out via redemptions, enabling them to shift portfolios without immediately realizing the built-in gain.
Bessent adopted a harsher tone regarding these Section 351 conversions, declaring that the transactions “don’t work under existing law.”
The IRS stated these setups can be reclassified as taxable exchanges, placing them further along in the government’s enforcement cycle than the digital-asset approach outlined in the concurrent notice.
Crypto in-kind infrastructure has already reached billions
This regulatory push follows a period where in-kind transfers quickly grew into a foundational element of US crypto fund operations.
BlackRock’s iShares Bitcoin Trust ETF (IBIT) distributed approximately $5.49 billion worth of Bitcoin via in-kind redemptions during the first half of 2026, according to recent quarterly filings, with roughly $3.85 billion of that volume occurring in the second quarter.
Meanwhile, its iShares Ethereum Trust ETF (ETHA) distributed another $1.72 billion of Ethereum in kind through June, bringing the combined six-month total for the two BlackRock funds to roughly $7.22 billion.
Over the same timeframe, IBIT also brought in about $9.36 billion of Bitcoin through in-kind creation mechanisms, illustrating how rapidly direct crypto transfers between funds and authorized participants have scaled since the SEC moved away from cash-only structures.
These operations do not imply that BlackRock is utilizing the specific strategy flagged by the Treasury.
Both IBIT and ETHA function as grantor trusts for federal income tax purposes, meaning any gains or losses pass straight through to shareholders rather than undergoing the RIC income test highlighted in the IRS notice.
Even so, their volume demonstrates the sheer size of the infrastructure currently accessible to funds aiming to move crypto assets in kind.
The Treasury’s concerns are directed at a distinct group: RICs that gain digital-asset exposure either directly or through grantor trusts and subsequently utilize redemptions to clear out appreciated assets whose gains might otherwise complicate the 90% threshold.
This distinction could gain importance as asset managers weave crypto exposure into multi-asset, income-generating, and actively managed ETF strategies instead of sticking strictly to standalone Bitcoin or Ethereum products.
Fund managers may face scrutiny before new rules arrive
The Treasury retains multiple avenues for its next course of action.
Notice 2026-62 indicates that regulators could respond by issuing new rules, revenue rulings, or alternative guidance, and may designate specific structures as transactions of interest or listed transactions—classifications that trigger stringent reporting mandates.
Any forthcoming guidance would not necessarily be restricted to future trades.
Officials cautioned that regulatory measures could apply prospectively or, where permitted by law, retroactively to transactions executed prior to the publication of the guidance. Furthermore, the IRS noted it retains the authority to contest questionable investment-fund strategies during audits under existing laws without waiting for fresh regulations.
As a result, managers relying on crypto-linked RIC frameworks may need to reevaluate their exposure before the Treasury finalizes a new regulatory standard.
Funds whose tax strategies rely on purging appreciated digital assets through redemption baskets could face pressure to substantiate the economic rationale behind those trades, restructure their redemption baskets, or scale back designs that depend on omitting those gains from RIC income computations.
For product developers engineering the next wave of crypto ETFs, this regulatory uncertainty could function as a structural barrier. Strategies that appeared tax-efficient under previous interpretations may now demand alternative portfolio mechanics, additional legal clearances, or a greater safety buffer prior to launching.
Frequently Asked Questions
What is the IRS investigating regarding crypto ETFs?
The IRS and Treasury Department are reviewing a tax strategy where certain ETFs use in-kind redemptions of appreciated digital assets or commodities to bypass gains calculations, potentially stretching tax provisions beyond their intended scope.
Are standard in-kind ETF redemptions banned?
No. The Treasury stopped short of challenging conventional ETF redemptions, focusing instead on specific structures that use these transactions to achieve tax outcomes disconnected from the fund’s underlying economics.
How does the 90% tax test apply to RICs?
To keep favorable tax treatment, regulated investment companies (RICs) must earn at least 90% of their annual gross income from qualifying sources. Some ETFs have argued they can exclude gains from assets outside those categories from the calculation.
How much crypto has moved through in-kind ETF infrastructure?
BlackRock’s IBIT and ETHA distributed roughly $7.22 billion combined in Bitcoin and Ethereum through in-kind redemptions during the first six months of 2026, while IBIT received about $9.36 billion in Bitcoin via in-kind creations.
Could new IRS rules apply retroactively?
Yes. The agencies warned that future actions or guidance could be applied either prospectively or retroactively to completed transactions where legal authority permits, and the IRS can challenge strategies under existing laws immediately.
