The U.S. Treasury Department and Internal Revenue Service have issued guidance increasing scrutiny of certain ETF transactions used by wealthy investors to defer capital gains taxes. Financial, investment and tax advisers involved in these arrangements are also under scrutiny.

The focus is on Section 351 transactions, in which investors contribute appreciated stocks to a newly established ETF in exchange for fund shares. Qualifying transactions can defer recognition of capital gains. However, arrangements in which the ETF quickly transfers those stocks out, effectively giving investors a different portfolio without recognizing gains, may face challenges from tax authorities.

The guidance does not reject all Section 351 transactions. The notice does not address contributions of assets that match an ETF’s investment strategy and are intended to be held over the long term.

Key concerns include prearranged transactions, rapid redemptions and substantial differences between the contributed and distributed portfolios. The meaning of “shortly after” remains undefined, leaving uncertainty over how the guidance will apply.