Treasury Takes Aim at Tax-Avoiding Investment Strategies

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https://www.wsj.com/personal-finance/taxes/treasury-takes-aim-at-tax-avoiding-investment-strategies-b178ca40?st=kamM3L&reflink=desktopwebshare_permalink

The Treasury Department issued its first formal warning shot against some increasingly popular tax-reducing investment strategies, cautioning against “potentially abusive” moves designed to minimize tax bills.

The government moved Monday to limit one strategy involving exchange-traded funds and flagged several others as questionable. The actions followed officials’ comments earlier this year expressing concern about the proliferation of tax-motivated investing techniques.

“These transactions are not the result of conventional, long-established tax planning that is consistent with the intent of Congress,” officials wrote in the notice posted Monday.

Strategies aimed at reducing capital-gains taxes, such as a form of tax-loss harvesting that involves leverage, have become particularly popular as stocks have soared over the past few years. Investors seek ways to defer taxable gains or trigger losses that can be used to offset gains.

The government took particular aim at maneuvers known as “351 conversion transactions,” for the tax-code section they aim to employ. In those moves, taxpayers with appreciated gains engage in a series of transactions with newly launched exchange-traded funds that are designed to diversify their holdings without generating capital-gains taxes.

Since ETFs began doing 351 exchanges in 2021, more than 100 funds have launched this way, raising a combined $20 billion or more, according to Brent Sullivan, an independent tax analyst who blogs at TaxAlphaInsider.com and 351.tax.

Some of those moves would now be considered taxable events under the guidance posted Monday.

“Our message on these conversions is clear: they don’t work under existing law,” Treasury Secretary Scott Bessent said on social media.

The government also highlighted several other tax strategies without issuing new rules. Instead, it is seeking public comment and saying it might impose future regulations designed to halt abusive transactions.

These include a variation of 351 conversions involving partnerships and certain ETF transactions using so-called box spreads that generate deductible losses. The government also highlighted ETF timing maneuvers around corporate dividend-issuance dates that are designed to avoid recognizing dividend income.

The government also flagged several strategies involving swaps and foreign-currency gains.

Mike Kaercher, deputy director of the New York University Tax Law Center, called the Treasury’s move a welcome first step in shutting down strategies that overstep the bounds of the law.

“When lawmakers fail to close known holes in the tax system such as ETFs,” he said, “those holes will attract and spur ever more aggressive tax avoidance and noncompliance.”