Tax efficiency can be an important part of a sound investment plan, but it should not become the investment thesis itself. As the IRS examines several increasingly popular tax-driven strategies, the latest developments reinforce our preference for investment approaches that are understandable, transparent, and grounded in sound economics. Tax efficiency should support the plan, not define it.
Tax-aware investing has become one of the fastest-growing areas of wealth management over the last few years. By some estimates, tax-aware long-short strategies alone have attracted more than $150 billion in roughly three years [1], and about $23 billion has been contributed to new ETFs through so-called Section 351 conversions [2]. At Hollow Brook, we believe thoughtful tax management is an important component of preserving and compounding wealth. However, tax efficiency should be a byproduct of a sound investment strategy, not the primary driver of it. Don’t let the tax tail wag the dog.
Recent warnings by the U.S. Treasury Department and the IRS reinforce a principle that has long guided our investment process: if a strategy appears too good to be true, additional scrutiny is warranted. Notably, Treasury officials used that same phrase to describe some of these trades at an industry seminar in July [3].
On September 28, the Treasury Department and the IRS issued Notice 2026-62, signaling potential action on a range of tax-oriented investment strategies, along with Revenue Ruling 2026-20, which addresses Section 351 ETF conversions directly [3][5]. The strategies of concern include:
Importantly, officials have said the routine creation and redemption process that makes ETFs tax-efficient is not the issue; their concern is with transactions that combine it with other tactics to reach results at odds with the law’s intent [2]. Notably, the Treasury indicated that traditional ETF seeding arrangements and longstanding in-kind creation/redemption practices remain outside the scope of these concerns when they are tied to the fund's genuine investment objective.
The government's concern is that some of these strategies appear to be driven primarily by tax outcomes rather than genuine investment activity. The Treasury officials described several of these transactions as potentially abusive in July [3], and in the notice the IRS wrote that certain tax-aware funds "appear to be primarily tax-motivated rather than being directed toward generating an economic return from genuine investment activity" [1]. The scale of the tax benefits helps explain the attention: one large tax-aware fund reportedly recorded ordinary losses equal to 28% of invested capital in 2025 [1]. The agencies also warned that any guidance they ultimately publish could apply retroactively to transactions that have already taken place [1].
Like many investment advisory firms, Hollow Brook evaluated several tax-aware strategies as they gained popularity. While the headline benefits could appear compelling, our due diligence ultimately led us to remain on the sidelines.
Our principal concerns included:
Complexity
Many of these structures relied on sophisticated derivatives, swaps, short positions, or ETF mechanics that made the relationship between investment risk and expected return difficult to evaluate.
Leverage and Counterparty Exposure
A number of strategies incorporated leverage or derivative overlays that introduced risks beyond those present in traditional long-term investing. Before custodians imposed limits, some long-short portfolios ran as much as 300% long and 200% short [4]. In our view, adding sources of risk solely to pursue tax benefits can create unintended portfolio consequences.
Liquidity Considerations
During periods of market stress, liquidity can become far more valuable than the advertised tax benefits. For some of the strategies we reviewed, exiting would have meant realizing the very gains the strategy was designed to defer, which can leave investors effectively locked in. Access can also change quickly: Fidelity stopped RIAs from opening new long-short accounts and raised financing costs for some existing clients, while Schwab capped the share of an RIA’s assets that can be allocated to these strategies [4].
Regulatory Uncertainty
Of these concerns, regulatory risk has proven the most immediate. The strategies often relied upon favorable interpretations of tax rules that could evolve or be clarified over time. As recent IRS and Treasury actions demonstrate, tax outcomes that appear attractive today may not be permanent tomorrow.
At Hollow Brook, we believe effective tax management should be integrated into a broader investment philosophy rather than pursued through increasingly complex structures.
Currently our preferred approaches focus on:
These techniques may not generate headlines, but they are designed to be transparent and durable, and they are aligned with our broader objective of preserving and compounding client capital over full market cycles.
Periods of innovation often create opportunities, but they can also tempt investors to prioritize short term outcomes over the full economics of an investment. The latest Treasury and IRS actions serve as a timely reminder that investment success should remain grounded in sound economics, transparent risk-taking, and long-term discipline.
If you currently hold one of the strategies described above, this may be an appropriate time to review it with your advisor and tax professional. As guidance continues to develop, we will monitor these developments closely. Our team remains available to discuss the potential implications and help evaluate appropriate next steps.
Final Perspective: Tax efficiency can be an important part of a sound investment plan, but it should not become the investment thesis itself. We continue to favor investment approaches that are understandable, transparent, and grounded in sound economics. Tax efficiency should support the plan, not define it.
[1] Bloomberg, “Tax-Slashing ‘Holy Grail’ Popularized by AQR Dealt IRS Warning,” September 28, 2026. https://www.bloomberg.com/news/articles/2026-09-28/tax-slashing-holy-grail-popularized-by-aqr-dealt-irs-warning
[2] Bloomberg, “‘Black Holes’ for Capital-Gains Tax Come Under Treasury Fire,” September 29, 2026. https://www.wealthmanagement.com/etfs/-black-holes-for-capital-gains-tax-come-under-treasury-fire
[3] Bloomberg, “Treasury Takes Aim at Wall Street Tax Trades in New Notice,” September 28, 2026. https://www.bloomberg.com/news/articles/2026-09-28/treasury-takes-aim-at-wall-street-tax-trades-in-new-notice
[4] InvestmentNews, “Custodians Curb Long-Short SMA Strategies,” July 30, 2026. https://www.investmentnews.com/equities/custodians-curb-long-short-sma-strategies/267624
[5] InvestmentNews, “IRS Targets 351 ETF Conversions in New Guidance on Tax Strategies,” September 29, 2026. https://www.investmentnews.com/etfs/irs-targets-351-etf-conversions-in-new-guidance-on-tax-strategies/268394
Disclaimer:
This document does not constitute an offer of investment advisor services by Hollow Brook Wealth Management LLC (“HBWM”) or any of its affiliates. This document has been prepared for informational purposes only and is not intended to provide specific investment advice or recommendations to any recipient.
Past performance is no guarantee of future results. Inherent in any investment is the potential for loss of all or any portion of the investment. This information is for discussion purposes only. It is not intended to supplement or replace the disclosures made in Part 2 of HBWM’s Form ADV.
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Any discussion of tax-efficient strategies is for informational purposes only and is not intended to provide, and should not be relied upon for, tax advice. Clients should consult with their own tax professional regarding the tax consequences of specific investments or strategies.