Crypto exchange-traded funds (ETFs) have been placed on alert by the IRS. A directive published Monday highlights funds holding digital assets that utilize a trading mechanism to avoid recording capital gains.
Simultaneously, the agency eliminated a tax-free stock swap favored by affluent investors. Both actions focus on the same underlying ETF regulation.
How Crypto ETFs Keep Gains Off the Books
The majority of U.S. funds enjoy a special tax designation, remaining exempt from corporate tax provided that a minimum of 90% of their revenue originates from dividends, interest, and stock gains.
Profits generated from commodities and cryptocurrencies are excluded from this calculation. Exceeding the threshold with this type of revenue jeopardizes the tax exemption.
According to the IRS, certain ETFs bypassed this restriction by transferring appreciating digital assets to Wall Street trading firms in exchange for fund shares. Existing regulations allow funds to execute these transfers without logging a taxable gain.
Avoiding a recorded gain prevents problematic income. The advisory specifies that this mechanism applies regardless of whether the fund holds the assets directly or through a trust structure.
Which Crypto Funds Are at Risk
While the notice mentions no specific funds, spot Bitcoin ETFs—such as BlackRock’s Bitcoin ETF—are structured differently. SEC filings indicate that the iShares Bitcoin Trust operates as a grantor trust, passing its tax responsibilities directly to shareholders.
The exposure instead impacts standard funds that invest in crypto or shares of comparable trusts. Funds holding these assets via offshore subsidiaries are exempt from the notice.
Furthermore, the IRS cautioned that any prospective remedies could be applied retroactively.
“Any such guidance could apply prospectively only or retroactively to transactions that already have taken place…”
Public comments close on October 28.
The IRS Also Shut a Tax-Free Stock Swap
Alongside the warning, the agency released Revenue Ruling 2026-20, which terminates Section 351 conversions. These previously allowed wealthy investors to exchange surging equities for diversified funds without incurring taxes.
“Sounds like it’s just cracking down on ones that break from spirit of law,” noted Eric Balchunas, an ETF expert.
Under the previous setup, an investor contributed to a new ETF, which subsequently transferred the stock to a trading firm. The IRS now classifies this activity as a taxable sale.
Ed Zollars, a certified public accountant who authors Current Federal Tax Developments, advised financial professionals to audit previous client conversions.
Law firm Liskow noted that the Investment Company Institute (ICI), the primary trade organization for U.S. funds, previously informed the Treasury that these conversions provide portfolio diversification and reduced fees.