Rev. Rul. 2026-20 & Notice 2026-62: IRS Says Some §351 ETF Conversions Are Taxable—What RSU and Concentrated-Stock Investors Should Check | YCL | YCL CPA

Author: YCL CPA ｜ YCL Tax, Accounting & Advisory

Bottom line in one breath

On Monday, September 28, 2026, Treasury and the IRS released Revenue Ruling 2026-20 and Notice 2026-62. The ruling says that when an investor contributes an appreciated portfolio to a newly formed ETF under §351, and—as part of the same plan—the ETF quickly redeems an authorized participant (AP) with those contributed securities and ends up holding a materially different portfolio, the investor is treated as making a taxable exchange under §1001, not a tax-deferred §351 contribution. The notice flags a wider list of "tax-aware" fund strategies, warns that future guidance could apply retroactively and could label some deals listed transactions or transactions of interest, and asks for comments by Wednesday, October 28, 2026. If you are a Cary/RTP professional with concentrated RSU/ESPP stock or a large taxable brokerage account and an advisor has pitched a "§351 ETF exchange" or a "diversify without selling" product, review it before you sign or before year-end. This is compliance planning, not a promise of any tax result.

Background

§351 generally lets a person transfer property to a corporation for its stock without recognizing gain if the transferors control the corporation right after the exchange. §351(e) turns that off for transfers to an investment company that diversify the transferor's interests—but the regulations (Treas. Reg. §1.351-1(c)(6)) say a transfer of an already diversified portfolio (no more than 25% in one issuer and no more than 50% in five or fewer issuers) is not treated as diversification. ETFs are taxed as regulated investment companies (RICs), and §852(b)(6) lets a RIC distribute appreciated securities in kind when shares are redeemed without the fund recognizing gain. Some advisors combined these rules into a "§351 conversion": investors seed a new ETF with their appreciated stocks, then the ETF swaps those stocks out through AP redemptions so it holds what it actually wants to own. Industry data cited by law-firm commentary (Venable, September 30, 2026, citing BNY) counted 77 U.S. ETFs launched with roughly $16.6 billion of individual seed assets by June 2026. In Rev. Rul. 2026-20, the IRS applied substance-over-form and step-transaction principles, treated the ETF as a conduit, and concluded the investor exchanged those securities with the AP in a taxable transaction. The ruling says the result is the same with multiple investors.

Old market view vs. Rev. Rul. 2026-20 and Notice 2026-62

1. ETF seeding with a diversified portfolio: Old view—if your portfolio passes the 25%/50% test, contributing it to a new ETF is tax-deferred. Now: if, under the same plan, the ETF redeems an AP with your securities shortly afterward and ends up with a materially different portfolio, the IRS treats you as making a taxable exchange of those securities.

2. Ordinary ETF seeding: The notice expresses no view on §351 seeding with assets that fit the ETF's investment thesis and are intended and expected to be retained absent a substantial change in circumstances. There is no safe-harbor holding period or percentage test—the plan for the contributed assets is the key fact.

3. "Partnership variation" for concentrated stock: Old pitch—investors who are not diversified (for example, mostly one employer's stock) contribute to a partnership holding at least 20% non-securities assets, which then joins a §351 conversion. Now: the notice says Treasury and the IRS are considering guidance that such contributions do not qualify for nonrecognition or may be recharacterized. Commentary notes the notice does not address traditional exchange funds that skip the ETF conversion step.

4. Other strategies flagged: box-spread option ETFs, tiered-ETF dividend record-date strategies, using in-kind redemptions to keep gains out of the RIC 90% income test, and "tax-aware" partnership/separately managed account strategies using mixed-character straddles (§988/§1256), after-the-fact §988 elections, and selective swap terminations.

5. Timing of future rules: Old assumption—new rules apply going forward. Now: the notice says any further guidance could apply prospectively or retroactively, and the IRS may challenge these strategies on examination under existing law and judicial doctrines.

6. Ordinary ETF investors: Buying ETF shares in a brokerage account or 401(k) and the ETF's normal creation/redemption process are not the target; the notice focuses on atypical, prearranged uses.

Self-check: does this affect you?

1. If you contributed stock to a newly launched ETF in 2025 or 2026 in exchange for ETF shares, do you have the offering documents showing what the ETF planned to do with your securities—and did its holdings change materially soon after launch?

2. If you hold concentrated RSU or ESPP shares from an RTP employer and were offered a "diversify without selling" product, do you know whether it uses a partnership step followed by a §351 ETF conversion?

3. If you are a 2025 extension filer with any such transaction, has your preparer reviewed how it is reported on the return due Thursday, October 15, 2026, and whether disclosure is appropriate?

4. If you invest through a "tax-aware" hedge fund, private fund or separately managed account, does your Schedule K-1 or year-end report show large offsetting capital gains and ordinary losses from currency forwards, futures or swaps?

5. If you are a business owner who sold a company and now holds a large appreciated taxable portfolio, is your diversification plan built on conventional steps (phased sales, loss harvesting, charitable gifts) rather than a prearranged conversion?

Simplified example (illustration only—not a prediction or promised outcome)

A Cary couple (illustrative), filing jointly, holds a taxable brokerage portfolio of about $1,200,000 with a cost basis of $500,000. It passes the 25%/50% diversification test. In November 2026 an advisor proposes contributing it to a new ETF via §351. Under the plan, the ETF uses $1,000,000 of the contributed securities (basis $400,000) to redeem an AP within weeks and then holds a portfolio that matches its strategy, not the couple's stocks.

1. Position the promoter expected: no gain recognized in 2026; the couple's ETF shares carry over the old basis.

2. Under Rev. Rul. 2026-20's holding: the couple is treated as exchanging the $1,000,000 of securities with the AP, recognizing about $600,000 of gain in 2026. Assuming, for simplicity, the whole gain is long-term and taxed at 20% + 3.8% net investment income tax, federal tax is about $142,800; North Carolina's 3.99% 2026 rate adds about $23,940—roughly $166,740 in total.

3. If reported as non-taxable and later adjusted on examination: the couple could owe that tax plus interest, and an accuracy-related penalty of 20% of the federal underpayment (about $28,560) could be asserted, subject to defenses.

4. A conventional alternative: spread sales across 2026 and 2027, harvest losses elsewhere in the portfolio, and consider donating some appreciated shares to charity—planned with the tax brackets and the NIIT threshold in view.

Numbers are simplified: they ignore the 0%/15% capital-gain brackets, other income, deductions, basis details and state-specific rules. Real outcomes depend on your facts and documents.

Action timeline

1. Now (October 2026): if you did, or are considering, a §351 ETF contribution or exchange-fund product, collect the private placement memo / prospectus, contribution date, list of securities and basis, and the ETF's holdings after launch. Do not sign new subscription documents until your CPA and attorney review them.

2. By Thursday, October 15, 2026 (2025 extension filers): confirm how any 2025 contribution is reported and whether a disclosure statement (for example, Form 8275) should be discussed.

3. By Wednesday, October 28, 2026: comments on Notice 2026-62 are due to Treasury/IRS. Watch for follow-up guidance; if a strategy is later designated a listed transaction or transaction of interest, participants may need to file Form 8886, and penalties can apply for missed disclosures.

4. November–December 2026: run a year-end projection for concentrated positions: phased sales, loss harvesting (mind the wash-sale rule), charitable gifts of appreciated stock, and RSU vesting withholding. Last trading day for 2026 sales is Thursday, December 31, 2026.

5. Friday, January 15, 2027: fourth-quarter 2026 estimated tax payment if a large gain is recognized in 2026.

6. Thursday, April 15, 2027: 2026 federal and NC returns due (or extend). Keep every document from the transaction for at least the assessment period.

What YCL can do

1. Transaction review memo: a plain-language read of a §351 ETF, exchange-fund or "tax-aware" fund pitch against Rev. Rul. 2026-20 and Notice 2026-62, coordinated with your attorney and financial advisor.

2. Basis and gain reconstruction: lot-level cost basis for RSU/ESPP and brokerage holdings, including the common double-counting of RSU income on Form 1099-B.

3. Return reporting and disclosure: reporting positions for 2025 extension returns and 2026 returns, Form 8275 / Form 8886 evaluation, and amended-return analysis if needed.

4. Year-end concentrated-stock plan: multi-year sale schedule, NIIT and NC tax projection, charitable-gift timing, and estimated tax for January 15, 2027.

5. IRS examination support: responses to IRS letters and audits under Form 2848 representation.

6. Bilingual (EN/ZH) service with CPA Chenchen Liu and Gloria; offices in Cary (RTP) and Shanghai; Free Consultation.

FAQ

Q: What does Rev. Rul. 2026-20 say about §351 ETF conversions?

A: Rev. Rul. 2026-20, released September 28, 2026, says that when an investor transfers appreciated securities to a newly formed ETF and, as part of the same plan, the ETF redeems an authorized participant with those securities and ends up holding a materially different portfolio, the investor is treated as making a taxable exchange under §1001 with the authorized participant rather than a tax-deferred §351 contribution.

Q: Does Notice 2026-62 affect people who simply buy ETFs in a brokerage account or 401(k)?

A: Notice 2026-62 focuses on atypical, prearranged uses of in-kind redemptions and certain tax-aware fund strategies, not ordinary ETF purchases or the normal ETF creation and redemption process. It also says it expresses no view on §351 seeding with assets that fit the ETF's investment thesis and are intended to be retained.

Q: Could the new guidance apply to transactions done before September 28, 2026?

A: Notice 2026-62 states that any further guidance on the identified strategies could apply prospectively only or retroactively to transactions that have already taken place, and that the IRS may challenge abusive strategies on examination under existing law. Investors who completed a §351 ETF contribution in 2025 or 2026 should review the facts with a CPA.

Q: When are comments on Notice 2026-62 due?

A: Treasury and the IRS asked for written comments by October 28, 2026, with the subject line referencing Notice 2026-62. Comments submitted later may still be considered but might not be reflected in forthcoming guidance.

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Disclaimer

This article is general tax information only and is not tax, legal or investment advice for any person or business, and it is not a recommendation to buy, sell or hold any security or fund. It does not promise any tax result, penalty outcome or IRS position. Application depends on your facts, the transaction documents and current IRS guidance; consult licensed tax, legal and investment professionals for advice specific to you.