The U.S. Treasury Department took a significant step on Monday toward reining in Wall Street's tax-optimization investment boom.

A notice released by the Treasury indicates that the government may take action against a variety of related strategies, and a new IRS ruling would limit the tax benefits enjoyed by a rapidly growing ETF practice. The Treasury notice lists a batch of tax transactions similar to those described by Treasury officials at an industry symposium in July as "potentially abusive" and "too good to be true." These include hedge funds using ordinary losses generated by swaps and foreign exchange derivatives to offset income tax. Such transactions are central to strategies employed by products like AQR Capital Management's Delphi Plus fund. The list also includes so-called Box Spread ETFs, which use options to convert interest income into capital gains. The $15 billion Alpha Architect 1-3 Month Box ETF, which trades under the ticker BOXX, popularized this strategy. The U.S. government said it is considering issuing more guidance or taking further measures to address the transactions described in the notice. Possible actions include designating the strategies as "transactions of interest," meaning they are seen as having tax-avoidance potential and therefore require additional disclosure. The government is currently seeking more information.

Separately, the IRS issued a tax ruling warning that the tax treatment of so-called "351 conversions" may be "recategorized according to the substance of the transaction." These arrangements involve first injecting appreciated assets into an ETF and later removing those assets through in-kind redemptions, thereby avoiding capital gains tax. Such transactions have grown rapidly over the past two years because investors can use them to rebalance their portfolios without triggering capital gains tax. The IRS's latest decision targets ETFs that use the mechanism to convert a portfolio into one that is "substantially different" from the assets originally contributed.

In recent years, asset managers have rushed to launch various strategies under the so-called "tax alpha" boom, helping investors reduce their tax burden in addition to earning profits through trading. The Treasury notice did not name any specific products or issuers and mainly concerns two major categories of strategies. The first involves ETFs using the in-kind redemption mechanism to obtain tax benefits "inconsistent" with the mechanism's original purpose. In-kind redemptions have long helped ETFs avoid capital gains tax. Alpha Architect CEO and founder Wes Gray said, "I don't think there's anything new or different in their comments on Box Spread." He said, "This just looks like formalizing the discussion from their July event." An AQR spokesperson did not immediately respond to a request for comment. Affiliated Managers Group, which holds a stake in AQR, fell after the IRS news, down about 2% as of 2:28 p.m. New York time.