IRS signals potential crackdown on AQR-linked tax-aware trading strategy

The US Internal Revenue Service (IRS) has hinted at potential regulatory action targeting investment strategies aimed at generating tax benefits, with a particular focus on methods popularised by AQR Capital Management, according to Bloomberg. The agency said it intends to release guidance and may take additional measures to restrict certain transactions utilized by money managers to assist clients in reducing their tax burdens.

IRS officials specifically mentioned currency transactions and structures that combine equity swaps with futures futures as areas under scrutiny. Among the most recognized tax-aware investment approaches is AQR's Delphi Plus strategy, which had $6.6 billion in assets as of the second quarter of this year, based on Bloomberg's analysis.

This strategy is part of a wider movement towards tax-aware investing, where hedge funds employ long-short portfolios to harvest losses while maintaining market exposure. Although the primary focus of these strategies has traditionally been on reducing capital gains taxes, there has been growing interest in tactics designed to offset ordinary income as well.

Industry estimates suggest that tax-aware long-short strategies have attracted over $150 billion in assets over the past three years. These strategies typically involve maintaining a mix of long and short positions while realizing losing investments for tax purposes and allowing profitable positions to remain invested. The IRS stated that broad stock-focused strategies can be appropriate under established tax management methods, but expressed concern about transactions where tax considerations appear to be the main objective rather than investment returns.

The agency's warning may be particularly relevant for strategies designed to generate ordinary losses, which can offset income such as wages, salaries, and bonuses, not just capital gains. AQR has stated that it adjusts its strategies to comply with relevant regulations and guidance but declined to comment on the latest IRS announcement.