Treasury Sec. Bessent, IRS crack down on ETF strategy the wealthy are using to avoid capital gains taxes

• A July 2025 analysis found $22 billion in ETFs created for tax deferral purposes, accelerating significantly since 2024, with wealthy investors using Section 351 exchanges to transfer appreciated securities to newly formed ETFs and then quickly diversifying without recognizing gains.
• The IRS revenue ruling and notice target transactions where ETFs are 'merely a conduit' for transferring securities, but leave significant gray areas including what 'shortly after' means for timing restrictions, with public comments requested by October 28.
• Tax authorities are also scrutinizing related strategies including partnership transfers and options-based collar strategies, while alternative approaches like exchange funds and charitable remainder trusts remain viable for managing capital gains taxes.

Treasury and IRS Target Wealthy Investors' ETF Tax Avoidance Strategy

Key Development:

The U.S. Treasury and IRS issued new guidance cracking down on wealthy investors using ETF structures to avoid capital gains taxes through Section 351 exchanges. Treasury Secretary Scott Bessent stated authorities are "serious about cracking down on transactions designed to dodge taxes or exploit our federal tax code."

The Strategy Under Scrutiny:

Section 351 of the tax code allows investors to transfer property to a corporation in exchange for stock without recognizing capital gains. Wealthy individuals have been creating new ETFs with highly appreciated stocks, then quickly diversifying portfolios to avoid taxes. A July study found $22 billion in ETFs created for this purpose, deferring approximately $6.5 billion in capital gains, with activity accelerating since 2024.

Who's Affected:

This strategy is primarily used by ultra-high-net-worth individuals. Creation costs run $200,000-$300,000, with advisors suggesting minimum portfolios of $25-100 million in appreciated stocks to make it viable.

Regulatory Concerns:

The IRS ruled that ETFs serving as "mere conduits" for transferring securities to avoid taxes are problematic, particularly when portfolios become "materially different" shortly after contribution. However, "shortly after" remains undefined, creating a gray area awaiting further clarification.

What's Still Allowed:

Legitimate Section 351 transactions remain valid when ETFs retain assets consistent with their investment thesis, absent substantial circumstance changes.

Additional Implications:

Tax authorities are also examining partnership transfers related to Section 351 conversions and ETF buffer strategies. Comments on the notice are requested by October 28. Congress may consider narrowing ETF tax benefits. Alternative strategies include exchange funds and charitable remainder trusts.