The US Treasury is stepping up scrutiny of tax optimization strategies used by Wall Street's high-net-worth investors, taking concrete action for the first time against transaction arrangements it believes may carry abuse risks.

The Treasury issued a notice on Monday stating it may impose restrictions on tax strategies deemed "potentially abusive." At the same time, the Internal Revenue Service (IRS) released a ruling targeting certain transaction methods that use ETF structures to circumvent capital gains taxes.

The Treasury said it is investigating a range of strategies that "attempt to produce tax outcomes inconsistent with the purpose and proper application of federal tax rules," and indicated that further guidance or other regulatory actions may follow.

The action centers on a transaction method known as the "351 conversion." This strategy allows investors to transfer already-appreciated assets into an ETF structure, avoiding an immediate capital gains tax trigger when adjusting their portfolios.

US Treasury Secretary Bessent said on social platform X that such conversions "do not comply with existing law," and stated that the Treasury will crack down on "transactions designed to evade taxes or exploit loopholes in federal tax law."

Tax Alpha Strategies Expand Rapidly

Over the past few years, rising US stock markets have driven investors to hold large amounts of unrealized gains, making tax reduction an increasingly important focus for certain institutions and wealthy investors.

So-called "tax alpha" refers to investors reducing tax costs through asset allocation, trading structures, and tax planning to improve after-tax investment returns.

Citing data, the Financial Times reported that hedge funds offering related strategies attracted more than $90 billion in capital from early 2025 through April of this year. Since 2021, ETFs created through 351 conversions have raised at least $21 billion cumulatively.

These strategies typically exploit the ETF-specific "in-kind creation and redemption" mechanism. US investors can generally adjust ETF holdings through securities exchanges rather than cash transactions, thereby deferring capital gains taxes.

However, in its latest ruling, the IRS stated that certain transactions should be treated as taxable asset exchanges and can no longer enjoy the original tax treatment.

Brent Sullivan, an independent tax analyst and editor of Tax Alpha Insider, said the ruling has significant implications for the ETF market, but actual enforcement will still depend on the facts and circumstances of each transaction. He noted that the action will not eliminate all normal 351 conversion tax planning.

Quantitative Funds and ETF Industry Face Reassessment

The action is not aimed at a single trading model. In its notice, the Treasury stated it will further gather information on strategies used by "tax-sensitive funds" and listed multiple ETF-related operations, including 351 conversions.

This is the Treasury's first escalation since an industry meeting in July of this year. At that time, Treasury officials said they would not "turn a blind eye" to aggressive tax planning.

The Treasury also indicated that additional regulatory guidance may be issued in the future, and related measures could even have retroactive effect.

In the market, affected by the regulatory news, shares of Affiliated Managers Group, which holds a stake in quantitative investment firm AQR, fell about 2% at one point on Monday.

AQR is considered one of the key drivers of a new generation of tax-optimized investment strategies. In recent years, some hedge funds and quantitative institutions have incorporated tax efficiency into investment product design, using leveraged trading, programmatic trading, and systematic loss realization to improve investors' after-tax returns.

AQR and firms like Quantinno have driven the development of related strategies. These strategies involve extensive buying and selling of securities to realize tax losses within a portfolio while maintaining overall market exposure.

However, AQR has previously stated that the primary reason investors choose its strategies should still be investment returns themselves—pre-tax alpha—rather than relying solely on tax advantages.

Currently, the US Treasury has not fully banned the related strategies but is tightening regulatory boundaries through tax rulings and information collection. The future policy direction will depend on whether the Treasury issues further rules and how regulators distinguish legitimate tax planning from transaction arrangements deemed to exploit loopholes.