The U.S. Treasury Department and Internal Revenue Service on September 28 issued Notice 2026-62 and companion Revenue Ruling 2026-20, placing crypto ETF in-kind redemption strategies on a formal enforcement watchlist. BlackRock's iShares Bitcoin Trust ETF (IBIT) and iShares Ethereum Trust ETF (ET...
"Treasury is serious about cracking down on transactions designed to dodge taxes or exploit our federal tax code." — Scott Bessent, U.S. Treasury Secretary
The U.S. Treasury Department and Internal Revenue Service on September 28 issued Notice 2026-62 and companion Revenue Ruling 2026-20, placing crypto ETF in-kind redemption strategies on a formal enforcement watchlist. BlackRock's iShares Bitcoin Trust ETF (IBIT) and iShares Ethereum Trust ETF (ETHA) distributed a combined $7.22 billion in digital assets through in-kind redemptions during the first half of 2026 — $5.49 billion in Bitcoin and $1.72 billion in Ethereum — using a mechanism the IRS now flags as potentially abusive when deployed to eliminate taxable gain recognition.
The guidance arrives as the crypto ETF complex reaches $173.8 billion in total assets under management and as the broader Section 351 ETF conversion market has grown into a $23 billion business since 2021. Treasury did not ban in-kind redemptions outright but requested public comment by October 28 and signaled that certain arrangements may be designated "transactions of interest" or "listed transactions" — classifications that trigger mandatory Form 8886 disclosure and carry steep penalties for non-compliance.
The action represents the first direct federal challenge to the tax plumbing that has underpinned crypto ETF operational efficiency since the SEC approved in-kind creation and redemption for spot Bitcoin and Ethereum products in July 2025.
Notice 2026-62, published September 28, identifies several categories of ETF-related tax strategies the IRS considers inconsistent with federal tax law. The notice targets funds using in-kind redemptions under Section 852(b)(6) of the Internal Revenue Code to avoid recognizing gains on appreciated assets, including digital assets held directly or through grantor trusts.
Treasury Secretary Scott Bessent framed the action in broader terms. In a July 22 post, Bessent stated: "Tax rules should reward investment, not abusive financial engineering." On September 28, he was more direct, calling certain Section 351 conversion transactions arrangements that "don't work under existing law."
The notice does not propose a single rule. Instead, it outlines five distinct transaction categories under review and reserves the right to act through formal regulations, revenue rulings, or enforcement designations — including retroactive application where legal authority permits. Comments are due by October 28, 2026.
When the SEC approved in-kind creation and redemption for spot crypto ETFs in July 2025, it resolved a structural inefficiency. Previously, authorized participants (APs) — the large institutional firms that maintain ETF liquidity — could only create or redeem shares using cash. This forced a taxable sale or purchase of the underlying Bitcoin or Ethereum at every step.
Under in-kind mechanics, APs deliver or receive actual BTC or ETH in exchange for ETF shares. The asset moves once rather than being sold and repurchased. This eliminates slippage, tightens the spread between the ETF price and spot value, and — critically — removes a taxable event inside the fund.
Section 852(b)(6) of the tax code allows a regulated investment company (RIC) to distribute appreciated securities in redemption of its own shares without recognizing a gain. The fund effectively passes the unrealized appreciation to the redeeming party. Over time, these redemptions can strip a fund of its accumulated gains, producing what Bloomberg described as "black holes for capital-gains tax."
For crypto ETFs specifically, the IRS has flagged an additional concern: whether funds holding digital assets — which are classified as non-qualifying income for RIC purposes — use in-kind redemptions to manage the 90% qualifying-income threshold required under Section 851(b)(2). By distributing appreciated non-qualifying assets before they trigger income recognition, a fund can preserve its RIC status while keeping digital-asset exposure.
BlackRock's IBIT dominated the in-kind flow. According to CryptoSlate's analysis of fund filings:
| Fund | Asset | In-Kind Redemptions (H1 2026) | Q2 2026 Alone | |------|-------|-------------------------------|---------------| | IBIT (iShares Bitcoin Trust) | BTC | $5.49 billion | $3.85 billion | | ETHA (iShares Ethereum Trust) | ETH | $1.72 billion | — | | Combined | — | $7.22 billion | — |
On the creation side, IBIT received $9.36 billion in Bitcoin through in-kind creations during the same period. The net effect: billions in digital assets cycling through fund structures that may generate no taxable gain recognition at the fund level.
IBIT's assets under management stood at $62.6 billion as of late September 2026, making it the dominant product in a Bitcoin ETF market totaling $149.76 billion. Ethereum ETFs collectively held $24.05 billion, bringing total crypto ETF AUM to approximately $173.8 billion.
The average daily volume across CME crypto futures and options reached 279,800 contracts in H1 2026, equivalent to roughly $8.3 billion in daily notional value, according to CME Group. The in-kind redemption volume at BlackRock alone — roughly $1.2 billion per month — represented a material share of total crypto ETF operational flow.
Alongside Notice 2026-62, the IRS issued Revenue Ruling 2026-20, which directly addresses the fastest-growing corner of the ETF tax trade: the Section 351 conversion.
Section 351 of the tax code allows an investor to transfer appreciated property to a corporation in exchange for stock without recognizing a capital gain, provided diversification tests are met (no single issuer exceeding 25% of value; five largest issuers below 50%). Since 2021, more than 100 ETFs have launched with over $20 billion in assets seeded through 351 conversions, according to InvestmentNews.
The strategy works as follows: a wealthy investor holding a concentrated, appreciated stock position transfers it to a newly formed ETF. The ETF issues creation units. Over time, the ETF uses in-kind redemptions to swap out the original appreciated securities for a diversified portfolio. The investor ends up with a diversified ETF holding — without ever having sold the appreciated stock and triggered a taxable event.
Revenue Ruling 2026-20 shuts down the most aggressive version of this trade. The IRS concluded that where the contribution and subsequent redistribution are part of a "prearranged plan," the transaction constitutes a taxable exchange under Section 1001 rather than a tax-free transfer under Section 351. The step-transaction doctrine applies regardless of whether one investor or multiple investors participate.
According to the ruling, the ETF acted as an "impermissible conduit" when securities were briefly held and then distributed to third parties. The investor must recognize gain equal to the fair market value of the received property minus the contributed basis.
Tim Steffen, Director of Advanced Planning at Baird Private Wealth Management, told InvestmentNews: "The investor appetite for products that offer tax advantages continues to grow, so it's not surprising that some techniques are pushing the boundaries of what's allowed."
Notice 2026-62 identifies five distinct transaction categories:
1. Section 351 Conversion Transactions. Investors contribute appreciated assets to an ETF and use subsequent redemptions to swap portfolios without recognizing gain. Revenue Ruling 2026-20 now treats these as taxable.
2. Box Spread ETFs. Funds use options structures to convert interest income to long-term capital gains. Alpha Architect's 1-3 Month Box ETF (BOXX), which holds approximately $15 billion in assets, is the most prominent product in this category. The IRS flags ETFs that distribute appreciated option legs in redemptions before expiration, asserting Section 852(b)(6) nonrecognition.
3. Record Date Strategies. Parent ETFs holding shares of acquired ETFs redeem creation units before dividend record dates, attempting to eliminate dividend income recognition.
4. RIC Income Test Avoidance. Funds distribute non-qualifying appreciated assets — including commodities and digital assets — through Section 852(b)(6) redemptions, arguing that gains on these assets should be excluded from Section 851(b)(2) calculations.
5. Partnership Exchange Funds. Investors contribute non-diversified appreciated assets to partnerships holding 20%+ in real estate or commodities, then execute Section 351 conversions with ETFs, chaining Sections 351, 721, and 852(b)(6) together.
Category four is the one most directly applicable to crypto ETFs, as digital assets constitute non-qualifying income under current RIC rules.
Affiliated Managers Group, whose affiliates include firms offering tax-managed ETF strategies, fell approximately 1.5% following the announcement.
Industry reaction was mixed. Brent Sullivan, who writes the Tax Alpha Insider blog, told AdvisorHub: "Treasury is saying, 'We see you and we're going to start taking a closer look at this stuff.'"
Wes Gray, CEO of Alpha Architect, took a different view, telling AdvisorHub he did not "think there is anything new or different on their box spread comments. This seems to just be a formal version of their conversation at the July event."
The practical question for crypto ETF issuers is whether routine in-kind redemptions — the same mechanism that tightens spreads and reduces tracking error — will be treated differently from the more aggressive 351 conversion strategies. Notice 2026-62 does not draw a bright line. It identifies categories of concern and solicits comment rather than proposing specific rules.
For the $173.8 billion crypto ETF complex, the distinction matters. In-kind creation and redemption is not a peripheral tax optimization — it is the core operational mechanism that makes spot crypto ETFs function efficiently. Any regulatory action that restricts or imposes recognition requirements on routine in-kind flows would fundamentally alter the cost structure and tax efficiency of every spot Bitcoin and Ethereum ETF in the market.
The comment period closes October 28, 2026. Treasury has indicated several possible responses:
The notice explicitly states that any future action could apply retroactively to transactions already completed, to the extent legal authority permits under Section 7805(b).
For crypto ETF issuers, the immediate question is whether the IRS views standard in-kind flows as fundamentally different from the engineered 351 conversions that Revenue Ruling 2026-20 shut down. The notice does not answer that question. It raises it.
The IRS action does not shut down crypto ETF in-kind redemptions. It puts them under a spotlight. The distinction between routine operational flows and engineered tax avoidance is now the central regulatory question for a $173.8 billion asset class that has relied on in-kind mechanics for operational efficiency since July 2025.
Treasury's willingness to apply future rules retroactively introduces a new variable into ETF structuring decisions. Fund managers, authorized participants, and tax counsel must now evaluate whether existing in-kind practices fall within the categories identified in Notice 2026-62 — and whether the October 28 comment period will produce clarity or further ambiguity.
The $7.22 billion in crypto assets that moved through BlackRock's in-kind pipeline in six months illustrates both the scale and the stakes. For an industry that built its institutional credibility on tax-efficient wrapper structures, the IRS has delivered a clear message: the efficiency argument does not exempt these transactions from scrutiny.