IRS Increases Scrutiny of High-Net-Worth Investment Strategies

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The IRS has issued two important guidance documents that identify novel investment fund strategies that “purport to produce tax results that may be inconsistent with… federal tax rules.” Specifically, the IRS is looking at tax-free transfers, like conversions, redemptions and straddle transactions, and other new strategies that result in the generation of large tax losses.

Notice 2026-62 describes specific arrangements (listed below) that it intends to more closely review and potentially examine using existing tax principles like the step-transaction doctrine, the economic substance doctrine and the wash sale rules.

IRS also will more closely analyze Section 351 transactions involving the transfer of appreciated securities to exchange traded funds (EFTs), according to Revenue Ruling 2026-20, which was released concurrently with the Notice.

Targeted Strategies

Under the guidance, the following EFT and fund structures and “tax aware” strategies will get heightened scrutiny:

ETF conversion transactions: Moving appreciated portfolios into ETFs through a tax-free contribution followed by a conversion; the IRS says the steps are being chained together and may still trigger gain recognition.
RIC distribution and redemption techniques: Using in-kind redemptions, record-date planning or other fund mechanics to reduce taxable distributions or sidestep regulated investment company (RIC) income tests.
Partnership and derivative-based structures: Employing partnership exchanges, box spread positions or swap terminations to create questionable tax outcomes.
Tax-aware trading strategies: Pairing positions like gain and loss straddles or foreign-currency forwards to split ordinary and capital treatment in a selective, tax-favored way.

IRS Seeks Comments, Reassures Investors

The IRS is seeking feedback from the public on these transactions, including comments on how they work and how they should be taxed. The tax agency has already received a number of comments, which can be reviewed here.

The IRS reassured investors that it is drawing a line between ordinary tax planning and the specific structures in the Notice: it is not deeming every tax-aware investment strategy improper, and it recognizes that some tax-loss harvesting is a normal part of investing.

If you use any of the strategies described above, we recommend consulting your Frazier & Deeter tax advisor to evaluate whether the recent IRS guidance affects the tax treatment of your investments.