The IRS and the Treasury Department are taking a hard look at a tax strategy used by some crypto-linked ETFs to keep unrecognized gains out of the 90% income test that governs regulated investment companies. Treasury flagged the practice in a new notice and simultaneously issued Revenue Ruling 2026-20, which rejects certain prearranged transactions involving appreciated securities moved into and then quickly out of an ETF.
Treasury Secretary Scott Bessent didn't leave much room for interpretation. He said the agencies are "serious about cracking down on transactions designed to dodge taxes or exploit our federal tax code," and added that Section 351 conversion transactions "don't work under existing law."
What the 90% test actually requires
RICs — which include most of the US ETF industry — have to pull at least 90% of their annual gross income from qualifying sources: dividends, interest, and gains on stocks, securities, and certain currencies. Fail that test and the fund loses its pass-through tax status.
The wrinkle is Section 852(b)(6). It generally lets an ETF distribute appreciated property through qualifying in-kind redemptions without recognizing the embedded gain. Some funds have taken that a step further, arguing that unrecognized gains from those redemptions should also be excluded when they tally up whether they cleared the 90% threshold.
Treasury's notice points at funds holding commodities or digital assets, either directly or through a grantor trust. The government's concern: the strategy could let an ETF shrink the income subject to the 90% test no matter what its actual economic income looks like.
BlackRock's numbers show the scale
How much money is moving through these structures? BlackRock's iShares Bitcoin Trust ETF distributed roughly $5.49 billion of Bitcoin through in-kind redemptions in the first six months of 2026, according to its latest quarterly filing. About $3.85 billion of that came in the second quarter alone. The iShares Ethereum Trust ETF pushed out $1.72 billion of Ethereum in kind through June. Combined, the two funds distributed about $7.22 billion in six months.
The flows run both ways. IBIT took in about $9.36 billion of Bitcoin through in-kind creations over the same period.
There's a detail worth keeping straight: IBIT and ETHA are treated as grantor trusts for federal income-tax purposes. Gains and losses pass through to shareholders, so the RIC income test at the center of the IRS notice doesn't apply to them directly. Treasury's concern is a separate category — RICs that get digital-asset exposure directly or through vehicles like grantor trusts, then use redemptions to remove appreciated positions whose gains could otherwise complicate the 90% test.
The prearranged trade Treasury rejected
Revenue Ruling 2026-20 goes after a specific structure. Investors contribute appreciated securities to an ETF, then quickly pull those assets back out through redemptions. The result is a different portfolio without the investor initially recognizing the embedded gain. The IRS said these arrangements can be recharacterized as taxable exchanges. In other words, the agency isn't waiting for legislation — it's saying the tax treatment funds have been claiming doesn't hold up.
This is the part of the package with immediate teeth. A revenue ruling is the IRS stating its position on existing law, and it applies retroactively to arrangements that fit the described pattern.
Where this goes next
Treasury has requested information on the practice and says it's weighing what action, if any, should follow. That request for comment is the near-term item to watch — it will shape whether the government moves toward formal guidance, audit focus, or both. The SEC approved in-kind creations and redemptions for spot crypto exchange-traded products last year, which is what opened the door to these structures in the first place. Nothing in this week's notice proposes walking that back. The fight is about how the gains get counted, not whether the mechanism exists.
