The IRS Just Pointed a $7.2 Billion Question at Crypto ETFs — and the Answer Could Apply Retroactively
- The Treasury Department and IRS issued Notice 2026-62 and Revenue Ruling 2026-20 on Monday, Sept 28 — a coordinated strike at funds using in-kind redemptions to keep crypto and commodity gains off their tax books.
- At issue: a strategy that sidesteps the 90% gross-income test for tax-favoured fund status. BlackRock's IBIT and ETHA moved a combined $7.22 billion in in-kind crypto redemptions in the first half of 2026.
- The notice seeks comments by Oct 28 — and warns the coming guidance "could apply prospectively only or retroactively" to deals already done.
- Spot bitcoin ETFs built as grantor trusts — including IBIT itself — sit largely outside the target zone. The risk lands on conventional funds holding crypto on their own books.
Wall Street found a clever way to make billions in crypto gains disappear from the tax books. On Monday, the IRS said it noticed.
Treasury and the IRS fired a two-barrel shot: Revenue Ruling 2026-20, killing a popular tax-free ETF conversion manoeuvre, and Notice 2026-62, flagging fund strategies as potentially abusive — including the in-kind redemption machinery that moved $7.22 billion through two BlackRock crypto products in the first half of 2026.
What happened
Here's the trick. A regulated investment company gets pass-through tax treatment only if at least 90 percent of its gross income comes from dividends, interest, and gains on securities. Crypto and commodity profits don't count — too much of that income, and the fund's tax-favoured status is at risk.
Some funds engineered around it. When trading firms redeem big blocks of ETF shares, the fund hands them appreciated bitcoin or ether instead of cash. Under an existing nonrecognition rule, that transfer books no taxable gain at the fund level — no booked gain, no disqualifying income, no 90-percent-test problem. The gains effectively vanish from the fund's tax picture.
Notice 2026-62 says the agencies are reviewing whether that position holds — whether the fund owns the assets directly, holds them through trusts or custody, or routes them through an intermediary. Treasury Secretary Scott Bessent, per Bloomberg Tax, called the related Section 351 conversions transactions that "don't work under existing law." The notice also targets box-spread ETFs, identified straddles, hindsight currency elections, and selective swap terminations.
Latest verified facts
BlackRock's iShares Bitcoin Trust recorded $5.49 billion in bitcoin paid in kind for redemptions in H1 2026; the iShares Ethereum Trust recorded $1.72 billion in ether — $7.22 billion combined. The filings show the machinery's scale, though they don't establish either fund used the specific tax treatment under review.
Here's the crucial nuance: spot bitcoin products built as grantor trusts — IBIT included — sit outside the main blast zone, passing tax attributes straight to shareholders. The real exposure is conventional funds holding crypto, or shares of crypto trusts, on their own books. Offshore subsidiaries are explicitly outside the notice's scope.
Revenue Ruling 2026-20 is already binding: it treats a specific ETF conversion — contribute an appreciated portfolio under Section 351, then redeem those same securities to an authorized participant — as a taxable exchange, the ETF a mere conduit. It carries no prospective-only language, and revenue rulings ordinarily apply retroactively. Comments on the notice are due October 28.
Why it matters
This is the clearest signal yet that tax administrators intend to separate ordinary ETF plumbing from structured trades built to defer or recharacterise income. In-kind redemption is genuinely central to ETF tax efficiency — the IRS isn't attacking the engine, just funds that bolt crypto gains onto it to manufacture an outcome the statute never intended.
For crypto investors, the practical takeaway is narrower than the headlines but real. Hold a spot bitcoin ETF as a grantor trust and this notice isn't about you. But the message to the industry is unmistakable: the era of "the IRS hasn't said anything, so it must be fine" is ending.
Impact on the USA and the world
American fund complexes are in the crosshairs, but the notice's structure reaches further: offshore subsidiaries are explicitly out of scope, an obvious incentive to route digital-asset exposure through non-US vehicles. European crypto ETP issuers will watch the October 28 deadline closely — what the IRS finalises tends to become the template other tax authorities study.
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What happens next
Three things to watch. First, October 28 — the comment deadline. Expect the industry's heaviest hitters to argue in-kind redemptions are ordinary ETF mechanics and the notice is overbroad. Second, watch for the IRS to designate some strategies as "transactions of interest" or "listed transactions" — mandatory disclosure filings, the regulatory equivalent of floodlights.
Third, and most consequential: retroactivity. If the final guidance reaches back to completed transactions, funds that ran these structures in 2025–26 could face surprise tax bills — and investors, amended paperwork. The IRS just told Wall Street's tax engineers the free trial is over.