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The US Treasury on Monday took its first concrete steps to crack down on a series of strategies used by wealthy American investors to reduce their taxes.
The department warned it could crack down on “potentially abusive” tactics and issued a ruling targeting the aggressive use of ETFs to avoid taxable gains.
It said in an opinion that it was investigating the use of strategies that “purport to produce tax results that may be inconsistent with the intent and proper application of the relevant federal tax rules.”
In a follow-up ruling, the Internal Revenue Service targeted a strategy known as a 351 conversion, which allows investors with appreciated assets to rebalance their portfolios without incurring taxable gains.
“This is a seismic moment in the ETF market,” said Brent Sullivan, independent tax analyst and editor of the Tax Alpha Insider newsletter.
Strategies that help wealthy Americans minimize their tax bills have gained popularity in recent years, helped by a U.S. stock boom that has shifted some investors’ attention to “tax alpha,” or gains from reducing tax liabilities.
Hedge funds offering tax alpha strategies accumulated more than $90 billion between the start of 2025 and April this year, according to FT calculations. Since 2021, ETFs created from 351 conversions have raised a total of at least $21 billion, according to Tax Alpha Insider.
The 351 conversion is one of several strategies that take advantage of the favorable tax treatment of ETFs, which U.S. investors can typically use to avoid paying capital gains tax by trading “in kind” with market makers so that no money changes hands.
But in a ruling Monday, the IRS said it would treat some of those transactions as taxable exchanges.
“Our message on these conversions is clear: They do not work under existing law,” Treasury Secretary Scott Bessent wrote on X. “Treasury is serious about cracking down on transactions designed to dodge taxes or exploit our federal tax code,” he added.
Sullivan said the ruling targeted cases in which “someone brings in a portfolio of securities that is out of sync with the ETF’s prospectus, and then quickly washes out those securities via an in-kind redemption.”
He cautioned: “It will depend on the facts and circumstances of each case” and added that the ruling would not “kill…routine tax planning” that involves 351 conversion.
The Treasury notice said it was seeking more information on a series of “strategies used by tax-conscious funds” as well as a list of ETF maneuvers, including the 351 conversion.
The written notice marks Treasury’s first escalation since it expressed interest in investigating tax strategies at a trade event in July, where officials warned they would not turn a blind eye to aggressive planning.
Treasury added that it was also “considering issuing additional guidance or taking other actions to address the transactions described in this notice” and that such guidance could apply “retroactively.”
Shares of Affiliated Managers Group, which owns a stake in AQR, a pioneer of the latest generation of tax-aware investment strategies, fell 2 percent on Monday.
AQR is, by some estimates, the largest hedge fund in the world. Working with rival Quantinno, it popularized an approach that uses leverage and algorithmic trading to buy and short securities on a large scale and to systematically realize losses on positions.
AQR has previously said that the “primary attraction for investors” should be the performance of its strategies – “pre-tax alpha”, or market-beating performance – before any tax benefits.
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