IRS scrutinizes crypto ETF tax strategy amid $7.22 billion in redemptions

The Treasury Department and IRS are examining a tax strategy involving in-kind redemptions by crypto-linked ETFs. BlackRock's IBIT and ETHA distributed about $7.22 billion of crypto through in-kind redemptions in the first six months of 2026. IBIT distributed about $5.49 billion of Bitcoin during that period, according to its latest quarterly filing. About $3.85 billion of IBIT's redemptions occurred in the second quarter. ETHA distributed another $1.72 billion of Ethereum through June. IBIT also received about $9.36 billion of Bitcoin through in-kind creations during the six-month period. Neither fund is subject to the regulated investment company income test at issue because both are treated as grantor trusts for federal income-tax purposes. Regulated investment companies generally must derive at least 90% of annual gross income from qualifying sources to retain favorable tax treatment. ETFs can generally distribute appreciated property in qualifying redemptions without recognizing the gain under Section 852(b)(6). Treasury said some funds argue that gains not recognized on redemptions should also be excluded from the income test. Treasury said that approach could limit the income subject to the test regardless of a fund's actual economic income. The government has requested information and has not banned the practice. Notice 2026-62 says regulators could issue guidance or designate certain arrangements for heightened reporting. The agencies said any action could apply retroactively where their legal authority allows. The IRS said it can challenge an abusive investment-fund strategy under existing law without waiting for new guidance. Separately, Revenue Ruling 2026-20 rejects certain prearranged transactions involving contributions of appreciated securities to ETFs followed by redemptions.