The Internal Revenue Service has warned that some exchange-traded funds with digital-asset exposure could face scrutiny over tax strategies that may defer or avoid recognizing gains. In a notice released Monday, the agency said certain funds may be using in-kind redemptions involving appreciated crypto-related assets in ways that produce tax outcomes the IRS may challenge.

The notice does not identify specific products, but it points to regular funds that hold digital assets directly or own shares of crypto trusts. The agency also said any future guidance could be applied either prospectively or retroactively to past transactions, and it has set an October 28 deadline for public comments.

How the tax issue works

US regulated funds generally can avoid paying tax at the fund level if at least 90% of their income comes from qualifying sources such as dividends, interest, and gains from stocks. According to the IRS, income tied to crypto and commodities does not fit within that exemption.

The agency said some ETFs may have tried to work around that limitation by delivering appreciated digital-asset holdings to Wall Street trading firms that redeem fund shares. Through those in-kind redemptions, the funds may be able to avoid booking gains immediately or alter when those gains are recognized.

Which funds appear most exposed

The notice does not name any ETF sponsors or funds. It does, however, draw a distinction between structures. Spot Bitcoin ETFs are not all organized the same way, and the article notes that products such as the iShares Bitcoin Trust operate as grantor trusts, meaning tax attributes pass through to shareholders rather than being handled like those of a regular fund.

That leaves the apparent exposure with more conventional funds that directly hold crypto or hold interests in crypto trusts. Funds that obtain exposure through offshore subsidiaries may fall outside the scope described in the notice.

Part of a broader IRS push on ETF tax planning

The crypto ETF notice arrived alongside another IRS action aimed at a different strategy used in fund structures. In Revenue Ruling 2026-20, the agency addressed Section 351 exchanges that had allowed wealthy investors to contribute stock to a diversified fund without immediately triggering tax.

Under that ruling, those stock-for-fund conversions are to be treated as taxable sales. Advisers are reportedly reviewing prior client transactions in response. Although the two actions target different techniques, both focus on how ETF-related structures have been used to shape the timing or recognition of taxable gains.

Industry reaction and next step

The Investment Company Institute said these kinds of conversions can help investors diversify and lower fees, while some market observers described the IRS actions as an effort to narrow perceived loopholes. The agency has not yet announced a final rule for the crypto fund issue, and the notice leaves open whether any eventual fix would apply only going forward or also to earlier transactions.

For now, the next confirmed step is the public comment process. Responses to the IRS notice are due by October 28, after which the agency may decide whether and how to issue more formal guidance for affected crypto-related funds.

Source: beincrypto.com