Bessent's IRS Just Killed the 351 ETF Loophole — The $40B Offshore Flip and 4 Other Tricks Are Next on the List

A wealthy investor with a concentrated, appreciated stock position could transfer those shares into a newly formed ETF under Section 351 of the Internal Revenue Code, which generally allows property contributions to a corporation in exchange for its stock without recognizing gain. The ETF would then issue creation units and, as part of a prearranged plan, redeem those units in-kind — distributing the same appreciated securities to an authorized participant in a transaction intended to be tax-free under Section 852(b)(6). The economic effect: the investor exits the concentrated position with no immediate capital gains hit, holding diversified ETF shares instead.

Treasury and the IRS now treat the whole package — contribution plus redemption — as a single taxable exchange under Section 1001. The investor is, in substance, selling to the authorized participant, not contributing to a corporation.

Bessent's crackdown focuses on U.S. investors using ETFs to dodge capital gains. But a separate — and much larger — offshore tax play has been sitting in plain sight for years, and Treasury has not formally closed it. Per a Bloomberg analysis published Sept. 1, 2026, foreign institutions move roughly $40 billion every quarter between BlackRock's iShares Core S&P 500 ETF (IVV) and Vanguard's S&P 500 ETF (VOO), toggling around the ex-dividend date so they never technically hold either fund on the day the dividend is paid — sidestepping the U.S. withholding tax on dividends paid to non-residents.

Since 2024, BlackRock's ex-dividend date has been consistently earlier than Vanguard's, making the toggle mechanical. The same pattern shows up in BlackRock's SGOV Treasury bill ETF, where investors reportedly pull as much as $1.3 billion out just before the ex-div date. Bloomberg estimates the IVV/VOO trade alone saved foreign investors roughly $147 million in U.S. taxes last year.

Notice 2026-62 does not touch the IVV/VOO pattern directly — ordinary creations and redemptions are explicitly carved out. But Treasury is still collecting comments through Oct. 28, and the Vanguard/BlackRock flip is the largest, most visible anomaly sitting in the U.S. ETF plumbing.

Revenue Ruling 2026-20 is a sledgehammer aimed at one transaction. Notice 2026-62 is a fishing net. Treasury flagged four additional Section 852(b)(6) strategies and three categories of tax-aware fund strategies that it says produce \"too good to be true\" tax results — and it is asking for public comments on all of them by Oct. 28, 2026.

The §852(b)(6) list, beyond the 351 conversion, includes: in-kind distributions of non-qualifying assets (such as cryptocurrencies held via grantor trusts) used to exclude gain from a regulated investment company's 90% qualifying-income test; tiered ETF structures that pass through other ETFs in-kind to dodge underlying tax distributions; and box-spread/options ETFs that distribute appreciated options in-kind to avoid recognizing gain.

The \"tax-aware fund\" category covers multi-position strategies used by partnerships and separately managed accounts that manufacture capital losses to offset gains — what KPMG and other advisers describe as generating \"artificial\" losses that violate the purpose of the wash-sale and constructive-sale rules. Treasury is also still considering whether to characterize any of these as \"transactions of interest\" or \"listed transactions,\" which would force disclosure and impose strict-listing penalties on promoters and advisors.

Downstream, the platforms that sell 351 exchanges to high-net-worth clients are now exposed to compliance and reputational risk. Morgan Stanley is widely cited as the leading wealth platform in 351-exchange volume — directory site 351conversion.com points to its scale. JPMorgan's Asset & Wealth Management segment markets 351 ETF exchanges explicitly to clients. Charles Schwab's Advisor Services unit supports the trade. Franklin Templeton has its own 351 ETF product family, alongside providers like Alpha Architect and Cambria that operate exclusively in this niche.

Upstream, the ETF plumbing itself is concentrated in three authorized participants — major Wall Street banks whose market-making units handle the creations, redemptions, and in-kind distributions. Their share of ETF sponsor revenue is invisible at the line-item level but material at the segment level.

Notice 2026-62 flags a category that hits the crypto-ETF complex directly: ETFs that hold non-qualifying assets (such as cryptocurrencies) and use in-kind redemptions under §852(b)(6) to dispose of appreciated positions without recognizing gain. The IRS wants to know whether those gains should be excluded from the 90% qualifying-income test that preserves a fund's pass-through tax status.

The plumbing is real. BlackRock's iShares Bitcoin Trust (IBIT) distributed roughly $5.49 billion of bitcoin through in-kind redemptions in the first six months of 2026 — about $3.85 billion of that in Q2 alone. The iShares Ethereum Trust (ETHA) distributed about $1.72 billion of ether in-kind over the same period. Combined H1 in-kind: $7.22 billion across the two BlackRock products. IBIT also received about $9.36 billion of bitcoin via in-kind creations in H1.

Technically, IBIT and ETHA are treated as grantor trusts for federal tax purposes — gains and losses pass through to shareholders rather than going through the RIC income test. But Treasury is asking whether RICs that get digital-asset exposure via vehicles such as grantor trusts can exclude those in-kind gains from the 90% test. Any restriction would ripple through to the Franklin Templeton EZcrypto Bitcoin and Ether ETFs and other sponsor products that follow the same playbook.

On Sept. 30, 2026 — two days after the IRS published the 351 ruling — the New York Times reported that Treasury Secretary Scott Bessent had quietly settled his own long-running IRS dispute over a hedge-fund tax strategy used during his time running Key Square Capital Management. According to the report, Bessent avoided roughly $910,000 in Medicare taxes on his 2021, 2022, and 2023 hedge-fund income by channeling earnings through a limited partnership and treating them as business income exempt from the 3.8% surtax — a structure the IRS has been challenging in Tax Court for years.

Bessent, who served briefly as acting IRS commissioner before his Treasury confirmation, had set aside a reserve to pay the disputed taxes depending on how the courts ruled. The settlement lands at a moment when the same IRS is publicly tightening the screws on $300 million-plus of bespoke tax-avoidance ETF strategies. The optics are unmistakable: the Treasury Secretary credibly — and personally invested — is leading an enforcement push that his former colleagues on Wall Street have spent years resisting.

For investors, the trade is straightforward: this is a structural tightening that re-prices niche ETF economics rather than threatening the mainstream ETF wrapper. BlackRock, Vanguard, and State Street-style mega-issuers are insulated because ordinary ETF creation/redemption is preserved. Smaller, tax-aware, and bespoke-ETF sponsors carry the asymmetric risk — and the wealth platforms that promoted them carry the litigation and reputational overhang. The Vanguard/BlackRock IVV/VOO offshore flip is the elephant still in the room, and Treasury's comment-letter process is the natural venue for further action.