Tokenized Treasury Funds in 2026: A Securities, Tax, and Custody Compliance Framework (BlackRock BUIDL, Franklin BENJI, Ondo OUSG, Circle USYC)

Key Takeaways

• Tokenized treasury fund shares are securities. The SEC and CFTC’s March 17, 2026 Joint Interpretive Release addresses tokenized real-world assets within its digital-securities taxonomy at the Commission level, and the SEC staff’s January 28, 2026 Joint Staff Statement on Tokenized Securities confirms tokenization is a recordation modality that does not change the legal character of the underlying instrument.
• Custody duty disaggregates by allocator type. Investment Advisers Act Rule 206(4)-2 governs RIAs holding for SMA clients; family offices and corporate treasury teams have no federal Custody Rule duty; the privately-offered-securities exception at Rule 206(4)-2(b)(2) is theoretically available to Reg D feeders but unsettled in practice.
• Tax treatment depends on the underlying fund regime, not the wrapper. BENJI/FOBXX is a Subchapter M regulated investment company taxed under IRC §852(b)(2); BUIDL is a BVI foreign corporation with PFIC overlay under IRC §§1291-1298 on the §V.A framing; OUSG is partnership-classified at the feeder level with §7704 publicly-traded-partnership exposure on the §V.A framing; USYC is Reg S, non-U.S. Persons only.
• The smart contract is the Securities Act §5 compliance architecture. Allow-list-only transfer restrictions enforce the offering exemption at the protocol layer; AMM designs and shadow-class wrappers add §5 exposure and trigger the §7704 publicly-traded-partnership question for any partnership-taxed fund.
• The legal regime is settled; operational architecture is where launches will live or die. The issuer-side and allocator-side checklists at §VII.A and §VII.B are the operative diligence hooks.
• EU-facing allocators face a hard date. MiCA’s Article 143(3) transitional regime expires July 1, 2026; the fund share itself is a “transferable security” under MiFID II and outside MiCA scope, but the brokers, custodians, and on-chain venues routing EU access are CASPs whose authorization status determines whether the channel survives the cliff.

I. Why are tokenized treasury funds growing so fast?

Tokenized treasury funds crossed approximately $15 billion in aggregate assets under management by mid-May 2026, with four products dominating the category: Circle’s USYC at roughly $3 billion, Franklin Templeton’s BENJI and BlackRock’s BUIDL each at roughly $2.3 billion, and Ondo’s OUSG at roughly $670 million.¹ Two years ago this asset class did not exist at scale. Today it is large enough to attract registered investment advisers, family offices, corporate treasurers, and offshore fund allocators — and large enough that the legal architecture surrounding it deserves the same disciplined analysis the industry brings to any other multi-billion-dollar securities market.

The fund is the legal story; the wrapper is operational. The institutions allocating here are not allocating to crypto. They are allocating to short-duration U.S. Treasury exposure with a different settlement and recordkeeping rail underneath.

The growth itself has a regulatory cause. The GENIUS Act of 2025, signed into law on July 18, 2025, established the federal framework for payment stablecoins and — critically — provides that “[n]o permitted payment stablecoin issuer or foreign payment stablecoin issuer shall pay the holder of any payment stablecoin any form of interest or yield (whether in cash, tokens, or other consideration) solely in connection with the holding, use, or retention of such payment stablecoin.”² That single sentence created a regulatory vacuum for on-chain dollar yield. Tokenized treasury funds fill it lawfully. They are securities, not stablecoins; their distributions are fund distributions, not interest payments; and they reach institutional allocators through the same Reg D, Rule 2a-7, and Reg S architectures used for every other money-market and short-duration treasury product. The regulatory line that closed off yield-bearing stablecoins simultaneously routed institutional demand into a wrapper the law already understood. The wrapper that grew was the one that fit.

For EU-facing institutional allocators, a separate timing constraint applies. MiCA’s Article 143(3) transitional regime expires on July 1, 2026, after which crypto-asset service providers operating in the EU must hold MiCA CASP authorization or cease offering services to EU clients.³ Tokenized treasury fund shares themselves are “transferable securities” under MiFID II and fall outside MiCA’s crypto-asset scope — but the brokers, custodians, and on-chain venues that EU institutional allocators use to access these products are CASPs whose July 1, 2026 status determines whether the access channel survives the cliff. The fund passes the test; the rails may not. EU allocator counsel should be working the CASP authorization question now, not in late June.

The growth was a regulatory routing event. The yield-bearing wrapper that fit the existing law was the one that scaled.

II. What are the four tokenized treasury fund architectures?

“Tokenized treasury fund” is a category, not a product. Four architectures dominate it, and the SEC bisected the category along its operative custodial axis on January 28, 2026, when the Divisions of Corporation Finance, Investment Management, and Trading and Markets issued a joint staff statement on tokenized securities — the first of two 2026 SEC actions setting the analytical frame; the March 17, 2026 Joint Interpretive Release with the CFTC is the second, treated in §III.⁴ The Statement separates “issuer-sponsored tokenized securities” — where the fund issuer or its agent records the security on the master securityholder file on-chain — from “custodial tokenized securities,” where “the third party issues a crypto asset representing the underlying security, such as a tokenized security entitlement.”⁴ The Statement explicitly maps the custodial-tokenized branch to the UCC Article 8 indirect holding system as one operative path among several, not as the exclusive frame. That bisection maps cleanly onto the four products.

A scope caveat the table cannot carry: USYC is restricted to non-U.S. Persons as defined under the Securities Act of 1933 following Circle’s January 2025 acquisition of Hashnote. We retain USYC in the title because it remains the largest tokenized-treasury product by AUM and the category-naming reference point for institutional readers, but U.S. allocators should not be acquiring USYC directly; any U.S. exposure to Hashnote’s strategy would come through a separate Reg D feeder, in which case the feeder’s tax classification governs (see §V).

A fifth architecture is in queue. F/m Investments — an approximately $18 billion fixed-income manager whose flagship F/m US Treasury 3 Month Bill ETF (TBIL) reached roughly $7 billion in net assets by mid-May 2026 — filed an exemptive application with the SEC on January 21, 2026, seeking permission to record ownership of tokenized TBIL shares on a permissioned blockchain ledger. It is the first such application by an ETF issuer for tokenized shares of a registered investment company.⁶ The application remains pending as of publication. It should not be confused with F/m’s separately-granted dual-share-class exemptive relief, issued January 12, 2026 and published in the Federal Register on May 4, 2026, which addresses only the combination of ETF and mutual-fund share classes within a single fund and has nothing to do with tokenization.⁷

This taxonomy matters because every layer below it — securities classification, custody, tax, transfer-restriction architecture — inherits its grammar from these nine columns. The token standard is the delivery mechanism. The fund regime and the SEC’s issuer-tokenized-vs-third-party-custodial distinction are the legal substance. The distribution-mechanic variant — NAV-up, rebasing, daily-in-kind, or DRIP — drives the §V tax overlay. The qualified-custodian column drives the §IV Rule 206(4)-2 analysis and the UCC Article 8 ring-fence the staff statement assumes is operative.⁴

Read the table once. Everything that follows is a layered consequence of the row the allocator picks.

III. Are tokenized treasury funds securities?

Every row of the §II table results in a security, and two separate 2026 SEC actions place the conclusion beyond serious doubt. The first answers the categorical question — what kind of asset a tokenized fund share is. The second answers the within-category question — what tokenization does to the underlying instrument. The two sit at different levels of formal authority and are cleaner kept distinct.

The categorical anchor is the SEC and CFTC’s Joint Interpretive Release of March 17, 2026, “Application of the Federal Securities Laws to Certain Types of Crypto Assets and Certain Transactions Involving Crypto Assets,” Release Nos. 33-11412 and 34-105020.⁸ The release sorts crypto assets into five categories — digital commodities, digital collectibles, digital tools, stablecoins, and digital securities — and places tokenized fund shares in the digital-securities bucket. Two features matter. It is a Commission-level interpretation rather than a staff product, which means it speaks for the agency. And it is the first time the Commission itself has drawn the classification line for digital assets.

The within-category anchor is the Joint Staff Statement on Tokenized Securities of January 28, 2026, issued by the Divisions of Corporation Finance, Investment Management, and Trading and Markets.⁴ The Statement’s operative move is to treat tokenization as a recordation mechanism rather than a legal-character change: the wrapper is the books-and-records ledger; the security underneath is what it has always been. The issuer-tokenized and third-party-custodial taxonomy set out in §II follows from that premise.

For BENJI/FOBXX, the analysis is statutory. Shares of a registered open-end investment company are securities within the Securities Act’s enumerated definition at §2(a)(1) (15 U.S.C. §77b(a)(1)) and the Exchange Act’s parallel definition at §3(a)(10) (15 U.S.C. §78c(a)(10)), and BENJI/FOBXX is itself a “registered investment company” within Investment Company Act §2(a)(36) (15 U.S.C. §80a-2(a)(36)). The on-chain record is the transfer agent’s recordation; the legal instrument is the registered fund share, whether ownership is held off-chain, on-chain, or both.

For BUIDL, OUSG, and USYC, the analysis runs through Howey. The partnership, limited-liability-company, or foreign-corporate interest in each fund is itself a security as an investment contract under SEC v. W.J. Howey Co., 328 U.S. 293 (1946), and falls within §3(a)(10) independent of any wrapper. The token is a digital share certificate with embedded transfer restrictions enforced through a KYC’d allow-list — the recordation modality, not the legal instrument.

One category boundary is worth surfacing because the market continually blurs it: yield-bearing stablecoins are not tokenized treasury funds. Tokenized treasury funds are securities offerings whose holders own shares in a fund that owns Treasuries; yield-bearing stablecoins are a separate — and, post-GENIUS Act, sharply restricted — category covered in §I.

The March 17 release also changed the analytical authority underneath this section. The SEC’s 2019 Framework for “Investment Contract” Analysis of Digital Assets — a FinHub staff product the Commission had neither approved nor disapproved — was expressly superseded in the release’s operative text, though the release does not supersede or replace the Howey test itself, which remains binding precedent. The SEC.gov page that previously hosted the Framework now carries the title “Framework for ‘Investment Contract’ Analysis of Digital Assets (Withdrawn) [Superseded by Application of the Federal Securities Laws to Certain Types of Crypto Assets and Certain Transactions Involving Crypto Assets (Mar. 17, 2026)].”⁹ The substantive Howey analysis is unchanged. What changed is the rung of authority on which it sits.

Tokenized treasury exposure is investment-company or private-fund securities exposure with on-chain settlement. The wrapper changes the rails, not the regime.

IV. Who is the custodian when the fund share lives on-chain?

Investment Advisers Act Rule 206(4)-2 was written before on-chain securities existed. The SEC Division of Investment Management’s September 30, 2025 no-action letter responding to Simpson Thacher & Bartlett LLP is calibrated for state-chartered trust companies holding “Crypto Assets,” not for tokenized fund shares classified as “digital securities” under the March 17, 2026 release.¹⁰ The allocator’s custody duty is therefore three questions, not one, sorted by who is holding.

A. Registered investment advisers holding for SMA clients

For RIAs holding tokenized treasury fund shares for SMA clients, Rule 206(4)-2 applies, satisfied by two paths that should be layered, not conflated.

The first is the rule as written: the “qualified custodian” definition includes a bank as defined in Investment Advisers Act §202(a)(2).¹¹ BNY Mellon — BUIDL’s custodian — is such a bank; BUIDL’s chain therefore satisfies Rule 206(4)-2 on the bank-category prong without resort to the September 30 NAL. National-bank custody authority rests on 12 U.S.C. §24 (Seventh) and, where fiduciary, on 12 C.F.R. Part 9.

OCC Interpretive Letter 1183 (March 7, 2025) reaffirms IL 1170/1172/1174 for custody of crypto-assets and rescinds IL 1179’s supervisory non-objection prerequisite, but does not by its terms define tokenized fund shares as a category; it is supportive context, with 12 C.F.R. Part 12 recordkeeping operative pending OCC clarification.¹² The second path is the September 30 NAL, available for chains whose custodian is a state-chartered trust company — BitGo Trust Company, Coinbase Custody Trust Company NY, Fidelity Digital Asset Services LLC, each sourced to its individual relief rather than blanket-attributed to the letter. (Anchorage Digital Bank N.A. is a national trust bank chartered by the OCC, not a state-chartered trust company; it satisfies Rule 206(4)-2 through the bank-category prong at §(d)(6)(i) rather than through the September 30 NAL.) The caveat: as Morgan Lewis observes, the Letter “does not state that the current custody provisions … would be expanded to include those Crypto Assets not already in scope.”¹⁰ Whether tokenized fund shares fall within the NAL’s “Crypto Assets” frame is an interpretive question. The layered framing is defensible; it is not yet settled.

B. Family offices and treasury teams holding for own account

Rule 206(4)-2 does not reach allocators who are not RIAs holding for managed-account clients. Single-family offices structured under the Family Office Rule (17 C.F.R. § 275.202(a)(11)(G)-1) and corporate treasury teams investing the operating company’s own balance sheet have no federal Custody Rule duty.¹³ State-law fiduciary duties apply — prudent-investor analogues for trust structures, corporate-officer duties for treasury teams — but not Rule 206(4)-2. Many institutional family offices voluntarily hold to Rule 206(4)-2-equivalent standards as best practice rather than regulatory mandate. The distinction matters at diligence: an RIA cannot allocate before resolving the §IV.A path; a family office can.

C. Reg D feeders (allocators that themselves are RIA-managed funds)

Where an RIA’s allocator is itself a Reg D 506(c) feeder, a third path is theoretically available. Rule 206(4)-2(b)(2)‘s privately-offered-securities exception relieves the adviser of qualified-custodian compliance for securities acquired in a non-public offering, uncertificated and recorded on the books of the issuer or its transfer agent in the name of the client, and “transferable only with prior consent” of the issuer or holders.¹¹ Tokenized fund shares are arguably uncertificated — the on-chain record is the books-and-records ledger — but the books-and-records prong and the prior-consent prong are both live questions: the on-chain wallet may or may not satisfy the “in the name of the client” requirement, and the issuer’s allow-list operates as a pre-authorized whitelist rather than a per-transfer consent regime. The prevailing practice treats the exception as unavailable and routes allocators back to §IV.A. Until those questions resolve, satisfying §IV.A directly is the conservative posture.

D. Issuer-side framing

Allocator-side disaggregation does not relieve the issuer. Because some non-trivial fraction of any tokenized treasury fund’s holder base will be RIAs, issuer architecture must satisfy Rule 206(4)-2 even when the family-office and corporate-treasury slices have no such duty. The custodian-failure scenario is a separate analysis this article does not undertake; the holder-protection chain runs through UCC Article 8 (§§ 8-501, 8-503), the Bankruptcy Code’s stockbroker-liquidation provisions (§§ 741-752), state trust-company receivership, and — for offshore feeders — Cayman insolvency with a likely Chapter 15 proceeding.¹⁴ The January 28, 2026 staff statement frames the structure as “custodial tokenized securities” in which the third-party custodian issues a crypto asset “such as a tokenized security entitlement” representing the underlying security, and the staff treats the underlying holder-protection chain as a function of the contracts and recordkeeping arrangements between custodian and beneficial owner.⁴ Two facts follow: SIPC coverage is structurally unavailable for Reg D 506(c) feeders (their interests are unregistered investment contracts excluded from SIPA’s “security” definition; the named custodians are not SIPC members for digital-asset custody in any event); UCC Article 8 protection is contract-driven, turning on the financial-asset election under § 8-102(a)(9)(iii), and In re Celsius Network’s Earn-versus-Custody distinction shows that contract terms can shift assets inside or outside the estate.¹⁵ Allocators should require the § 8-503(a) ring-fence opinion and a custodian-receivership walkthrough before allocating; a companion piece in the forward series will treat that analysis at length.

Custody is where tokenization stops being a ledger choice and starts being a securities-law choice. Disaggregate by who is holding, demand the written custody opinion before the trade closes, and pair it with the custodian-failure analysis — Article 8, Bankruptcy, SIPC — at the same diligence pass.

V. How are tokenized treasury fund distributions taxed?

The federal income-tax characterization of a tokenized treasury fund distribution depends first on the underlying fund’s tax regime — which is not uniform across the four products — and second on the on-chain distribution mechanic. The most common allocator error is assuming a single tax framework applies. It does not — four products generate four different regimes.

A. The fund-regime split

BENJI/FOBXX is a Subchapter M regulated investment company under IRC §851.¹⁶ Distributions are taxed under §852: ordinary-income dividends per §852(b)(2), capital-gain dividends per §852(b)(3).¹⁶ The on-chain wrapper adds no novel tax issue because the BENJI token is the share — Franklin Templeton’s transfer agent uses the blockchain as the books-and-records ledger, but the entity-level RIC qualification and the shareholder-level distribution character are unchanged.

BUIDL is organized as a British Virgin Islands Limited Company. Under Treasury Regulation §301.7701-3 (the check-the-box regulations), an eligible foreign entity of this type defaults to foreign-corporation classification absent an affirmative Form 8832 election.¹⁷ BlackRock’s publicly available materials — including the Securitize STEP application’s representation that “U.S. taxable investors will also receive PFIC statements” — are consistent with foreign-corporation operation and PFIC classification under IRC §1297.⁵ U.S. holders should expect §1291 excess-distribution treatment, with the annual interest charge on amounts deferred from prior years, absent a §1295 QEF election. A §1296 mark-to-market election is likely unavailable because BUIDL tokens — restricted to qualified purchasers and trading only on permissioned platforms — are unlikely to be “marketable stock” under §1296(e).¹⁸ Form 8832 elections are not publicly filed; the article assumes default classification, but holders should confirm before allocating.

OUSG is structured as a feeder above BlackRock and other short-Treasury funds and is partnership-classified at the feeder level per the conventional understanding of the structure (Ondo’s public documentation does not state the federal tax classification expressly; allocators should request issuer confirmation before relying). U.S. holders pick up their distributive share of fund-level income items annually on Schedule K-1 under §704, and the §7704 publicly-traded-partnership analysis taken up in §VI applies.¹⁹ If OUSG turns out to be corporate or PFIC-classified at the feeder level, the §1291 / §1295 framework described above for BUIDL applies instead, and the §VI §7704 analysis is inapplicable to OUSG.

USYC, by its express terms, is restricted to non-U.S. Persons as defined under the Securities Act of 1933. The Hashnote International Short Duration Fund Ltd. (Cayman) and Circle International Bermuda Limited have no U.S. tax presence for their eligible holder base. U.S. allocators should not be acquiring USYC directly; any U.S. exposure would come through a separate Reg D feeder, in which case the feeder’s tax classification governs.

B. The distribution-mechanic split

Pure NAV-up tokens (OUSG) generate no change in the holder’s wallet balance as fund yield accrues; only the underlying NAV per token increases. There is no §1001 disposition until the holder sells, redeems, or otherwise disposes of the token, and treatment-on-disposition then follows the fund’s tax classification — partnership distributive-share income on K-1, or PFIC §1291 excess-distribution mechanics on disposition for foreign-corporation issuers.¹⁹

Daily-in-kind distribution tokens (BUIDL) accrue yield daily and distribute it daily via in-kind issuance of additional tokens to the holder’s wallet.⁵ Each daily issuance is plausibly a §1291 distribution for a PFIC issuer; the frequency reinforces the practical case for a §1295 QEF election, which cleanly avoids the §1291 averaging mechanics by taxing pro-rata ordinary earnings and net capital gains annually instead.¹⁸ Holders of BUIDL who do not elect QEF face daily §1291 events.

Rebasing tokens (rOUSG; certain USDC-yield products) increase the holder’s wallet balance periodically as yield accrues even absent any sale. The treatment is contested, but the safest and most defensible characterization is ordinary-income-on-receipt under §61 at the fair market value of the additional tokens received, by analogy to Rev. Rul. 2023-14 (staking rewards) — which extends the “dominion and control” timing principle of Rev. Rul. 2019-24 (hard fork) to periodic on-chain receipt of tokens — at the moment the rebase event places transferable tokens in the holder’s wallet.²⁰ For a corporate or PFIC issuer, the alternative §301 / §1291 characterization generally produces similar ordinary-income treatment. §1272 OID treatment is theoretically available but disfavored — fund tokens are equity-like rather than debt-like.

Distribution-and-reinvest tokens (BENJI) are standard fund DRIP: §852(b)(2) for ordinary-income distributions; §852(b)(3) for capital-gain distributions.¹⁶ Tokenization is the recordation modality and adds no novel tax issue.

C. Cross-cutting issues

§1256 mark-to-market does not apply: tokenized treasury fund shares are not regulated futures contracts, foreign currency contracts, nonequity options, dealer equity options, or dealer securities futures contracts within the §1256(b)(1) enumeration.²¹ §988 does not apply either: these funds hold U.S.-dollar-denominated assets and distribute USD-equivalent tokens or USDC, with no nonfunctional-currency exposure for U.S. holders.²¹

State-tax exposure deserves a flag for issuers touching California (Astraea Counsel’s home jurisdiction; comparable analyses run for other state issuer regimes). California Revenue and Taxation Code §23101(a) defines “doing business” as “actively engaging in any transaction for the purpose of financial or pecuniary gain or profit.” §23101(b) sets bright-line sales/property/payroll thresholds (inflation-adjusted by the Franchise Tax Board: $757,070 / $75,707 / $75,707 for 2025; 2026 figures pending FTB publication), but California Office of Tax Appeals decisions have rejected treating §23101(b)‘s factor thresholds as a safe harbor — sub-threshold issuers can still be “doing business” under §23101(a)‘s broader test.²² For foreign-domiciled tokenized funds whose transfer agent or smart-contract administration touches California, this matters.

No IRS revenue ruling addresses tokenized funds specifically as of May 2026. Notice 2014-21 is the foundational digital-asset baseline; Rev. Rul. 2019-24 supplies the constructive-receipt “dominion and control” principle; Rev. Rul. 2023-14 is narrowly limited to proof-of-stake validation rewards — instructive but not controlling for the broader on-chain-receipt category.²⁰

Tokenized treasury tax depends on the underlying fund’s tax regime first and the on-chain distribution mechanic second. If your product is anything other than BENJI/FOBXX, your tax counsel needs the prospectus and the smart-contract code — and rebasing tokens need that analysis regardless of the underlying regime.

VI. The smart contract is the §5 compliance architecture

The most under-engineered legal layer in tokenized treasury funds is what happens when a permissioned token trades secondarily. The §II taxonomy, the §III securities classification, and the §IV custody architecture are settled or settling; what is not settled is whether the transfer-restriction logic actually does §5 work. Most issuers have made architectural choices they have not fully thought through. The choice — not the chain — controls the §5 and §7704 exposure.

Three patterns dominate. Allow-list-only architecture, used by BUIDL, limits transfers to KYC’d wallets pre-cleared by the transfer agent; the token is effectively a Reg D restricted security with smart-contract enforcement of resale conditions. Lowest §5 exposure; most operationally rigid. Allow-list-plus-AMM-with-whitelisted-LPs — approximated by some Ondo OUSG variants — supplies on-chain liquidity between accredited counterparties on a permissioned pool. Moderate §5 exposure; meaningful operational benefit. The tokenized shadow class — a non-KYC’d wrapper around a KYC’d share, with an SPV holding the underlying interest — carries significant §5 exposure and is generally inadvisable for U.S. issuers.

The §5 question is not academic. Securities Act §5 requires registration or exemption for every offer and sale of a security.²³ On-chain, the transfer is the sale — and the order to sell is the offer. The smart contract is what lets the offer-and-sale happen or refuses it; transfer-restriction architecture is what the §5 compliance regime is asking the issuer to engineer. Framing it as KYC, user experience, or “permissioning” understates what the code is being asked to do as a matter of federal securities law.

The §7704 publicly-traded-partnership question is the live tax overlay for any partnership-taxed tokenized fund. IRC §7704 converts a partnership with publicly-traded interests into a corporation for tax purposes; the Treas. Reg. §1.7704-1 safe harbors are how partnership-taxed tokenized funds preserve flow-through treatment.²⁴ §7704 is irrelevant for BUIDL (foreign corporation under default Treas. Reg. §301.7701-3 classification, per §V.A), BENJI/FOBXX (registered investment company, not a partnership), and USYC (Cayman interests held only by non-U.S. Persons). §7704 is live for OUSG (on the §V.A framing) and any other partnership-taxed tokenized fund. Three layered defenses apply. First, the affirmative argument: allow-list-only architecture precludes “readily tradable” status on a secondary market within the meaning of §7704(b), because the Treas. Reg. §1.7704-1(c) “secondary market or the substantial equivalent thereof” definition — regular broker-dealer quotations, regular public bid-and-offer quotes with stand-ready-to-transact, an ongoing opportunity to sell through a public means, or comparable-regularity buy-sell access — describes none of the features of a permissioned-counterparty ledger.²⁴ Second, the §1.7704-1(j) de minimis safe harbor: interests are not readily tradable if “the sum of the percentage interests in partnership capital or profits transferred during the taxable year of the partnership (other than in transfers described in paragraph (e), (f), or (g) of this section) does not exceed 2 percent of the total interests in partnership capital or profits.”²⁴ High-velocity allocator rotation can breach 2 percent without anyone deciding to make it happen. Third, the §1.7704-1(h) private-placement safe harbor: all interests issued in non-registration-required transactions and no more than 100 partners during the taxable year.²⁴ The 100-partner prong is satisfied for funds with substantial minimum-investment and qualified-purchaser gates. The “non-public-offering” prong is a genuine open question for Reg D Rule 506(c) offerings that use general solicitation;²⁵ practitioner consensus generally treats (h) as available because §1.7704-1(h)(1)(i) speaks to whether registration was required rather than whether the offering was a “public offering,” and a 506(c) offering is exempt from §5 registration.²⁴ Issuers designing on-chain secondary liquidity for any partnership-taxed tokenized fund — particularly AMM-style designs — should obtain a §7704 opinion before launch, not after.

Issuers who treat allow-listing as a compliance feature are correct; issuers who treat it as a user-experience feature are missing the legal point. The smart contract IS the §5 compliance architecture. Build it that way, document it that way, audit it that way.

Compliance code or litigation exhibit. Issuers pick the framing at launch; the SEC picks the framing at examination.

VII. What should issuers and allocators check before launch / before allocating?

Tokenized treasury funds reward parties who do the legal work in advance and punish those who retrofit it; both checklists below are pre-launch and pre-allocation, not post-mortem.

A. For issuers

• Pick the fund regime first — 1940 Act registered, Reg D 506(c) private fund, or offshore foreign-corporation structure. The token standard is downstream of that choice, not the other way around.
• Pick the qualified custodian and the transfer agent in parallel with the regime. Both are load-bearing counterparties whose names go in the prospectus.
• Build transfer-restriction logic to satisfy §5 for every state in which a permitted holder could reside; geofencing alone is not a §5 compliance regime. The smart contract is the architecture.
• Document the tax distribution mechanic before the smart contract is audited. The code auditor cannot fix a tax-character flaw locked into a daily-distribution mechanic.
• Write the qualified-custody opinion before the first allocator’s diligence pack arrives. The §IV.A bank-category prong and the September 30, 2025 NAL each need addressing on the record.
• If on-chain secondary liquidity is contemplated — anything beyond allow-list-only transfer — obtain the §7704 opinion before launch, not after the 2 percent threshold in Treas. Reg. §1.7704-1(j) is breached.²⁴
• Plan the redemption mechanic for the foreseeable failure modes — fund liquidation, issuer wind-down, transfer-agent failure, custodian receivership. Each requires a contractual and on-chain path before launch.

B. For allocators

• Identify the fund regime by reading the prospectus — 1940 Act RIC, BVI foreign corporation, partnership feeder, or Cayman fund. Do not infer it from the token standard or the issuer’s brand.
• Demand the issuer’s written custody analysis and verify the qualified custodian’s identity and charter directly. A custodian name on a website is not a custody opinion.
• Confirm that your platform’s holding mechanic satisfies Rule 206(4)-2 for your client base, or confirm that Rule 206(4)-2 does not apply via the §IV.B and §IV.C disaggregation.¹¹
• Engage tax counsel on the distribution mechanic before allocating. Rebase mechanics are not what most allocators expect; for BUIDL — treated as a PFIC on the §V.A framing — evaluate the §1295 QEF election to avoid §1291 averaging on daily in-kind issuance.¹⁸
• Confirm that the transfer-restriction architecture matches your operational model for secondary liquidity, redemption, and internal transfers across affiliated accounts.
• Verify the issuer’s regulatory posture in your domicile. USYC is restricted to non-U.S. Persons under Regulation S; U.S. allocators should not acquire USYC directly, only through a separate Reg D feeder.
• For EU allocators, verify the counterparty’s MiCA CASP licensure status before the July 1, 2026 transitional cliff in Article 143(3). The fund share itself is a “transferable security” under MiFID II and outside MiCA’s crypto-asset scope, but the brokers, custodians, and on-chain venues routing EU access are CASPs whose authorization is the question.³
• Demand the issuer’s written custodian-failure analysis covering UCC Article 8 security-entitlement status (financial-asset election under §8-102(a)(9)(iii); §8-503(a) ring-fence opinion), bankruptcy-priority chain (trust-company receivership for the charter; Subchapter III; Cayman or Chapter 15 for offshore feeders), and SIPC analysis (typically unavailable for Reg D feeders, but confirm). The diligence pack is not complete without it.¹⁴

VIII. Frequently Asked Questions

Are tokenized treasury funds securities? Yes. These funds are interests in pooled investment vehicles holding U.S. Treasuries and satisfy each Howey prong; they are also enumerated as “investment contracts” within the Securities Act §2(a)(1) definition of security. The SEC and CFTC confirmed this analysis for tokenized real-world assets in their March 17, 2026 Joint Interpretive Release.⁸ See §III.

Is BlackRock BUIDL a 1940 Act registered fund? No. BUIDL is BlackRock USD Institutional Digital Liquidity Fund Ltd., a BVI entity offered as a §3(c)(7) private fund to qualified purchasers under Reg D Rule 506(c). It is not registered under the Investment Company Act of 1940. The “BlackRock” brand is asset-management, not regulatory status. See §II.

Can a registered investment adviser hold tokenized treasury funds for SMA clients? Yes, but Rule 206(4)-2 (the qualified-custody rule) governs. The adviser must use a qualified custodian under Rule 206(4)-2(d)(6), obtain a written custody analysis, and evaluate whether the privately-offered-securities exception at Rule 206(4)-2(b)(2) is available as an alternative path. The September 30, 2025 Simpson Thacher no-action letter clarified part — but not all — of this.¹⁰¹¹ See §IV.

Are tokenized treasury fund distributions taxed as ordinary income or capital gains? It depends on the underlying fund’s tax regime. RIC distributions (BENJI, FOBXX) are §852(b)(2) ordinary-income dividends.¹⁶ Foreign-corporation distributions (BUIDL, on the §V.A framing) are §301 ordinary-income to the holder and trigger PFIC analysis under §§1291-1298.⁵¹⁸ Partnership-taxed funds (OUSG, on the §V.A framing) flow through to the holder. See §V.

Is BUIDL FDIC insured? No. FDIC insurance covers deposit accounts at insured depository institutions up to $250,000 per depositor.²⁶ BUIDL is a security, not a deposit; its underlying assets are U.S. Treasury obligations held by a custodian, not deposits at a bank. The full faith and credit of the U.S. Government backs the underlying Treasuries; that is a different protection and does not apply at the fund-share level. See §II.

What happens if a tokenized fund share moves to a non-KYC’d wallet? It cannot — by design. Allow-list-only architectures (BUIDL) block the transfer at the smart-contract level; the transaction reverts. AMM-style designs route transfers through whitelisted liquidity pools and block transfers outside that whitelist by the same mechanism. The shadow-class architecture — a non-KYC’d wrapper around a KYC’d share — is the exception and carries significant §5 exposure for the U.S. issuer. See §VI.

Are tokenized treasury funds the same thing as yield-bearing stablecoins? No. Yield-bearing stablecoins are payment instruments that pay holders; the GENIUS Act of 2025 prohibits permitted payment stablecoin issuers from paying any yield “solely in connection with the holding, use, or retention” of the stablecoin.² Tokenized treasury funds are securities offering fund distributions through 1940 Act, Reg D, or Reg S architectures — an entirely different regulatory category. See §I.

IX. Closing

The wrapper is exciting; the law is not. That is the point. Tokenized treasury funds are growing because they let institutional money operate at 24/7 settlement speed inside a regime the institutions already know how to underwrite — the same Investment Company Act, Reg D, Reg S, and money-market architectures the SEC, the OCC, and the IRS have refined across nearly a century of practice. The legal work is mostly already done. The new work is operational: build the custody architecture, the transfer-restriction logic, the §7704 analysis, and the tax-distribution mechanic to match the law you are already inside. Issuers and allocators who do that work in advance are the ones who will own this asset class as it scales. The ones who treat tokenization as a regulatory exit will discover, at the worst possible moment, that it never was.

The custodian-failure analysis — UCC Article 8 entitlement priority, Bankruptcy Code Subchapter III, SIPC coverage, and Cayman insolvency law for offshore feeders — is the subject of the next piece in this series. It is a required companion read before allocating to any third-party-tokenized custodial product covered here.

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This article provides general information for educational purposes only and does not constitute legal advice. Tokenized fund regulation and securities, tax, and custody law are evolving rapidly. Consult qualified legal counsel for advice on your specific situation.

Footnotes

1. rwa.xyz, “Tokenized U.S. Treasuries” dashboard (data as of May 14, 2026), available at https://app.rwa.xyz/treasuries. ↩

2. Guiding and Establishing National Innovation for U.S. Stablecoins Act of 2025 (GENIUS Act), Pub. L. No. 119-27, § 4(a)(11) (signed July 18, 2025). The “solely in connection with” qualifier is the textual hook for the ongoing Circle/Coinbase three-party-model debate over distributions paid by an exchange to a stablecoin holder where the exchange is not the issuer. ↩ ↩²

3. Regulation (EU) 2023/1114 of the European Parliament and of the Council of 31 May 2023 on markets in crypto-assets (MiCA), art. 143(3), 2023 O.J. (L 150) 40, available at https://eur-lex.europa.eu/eli/reg/2023/1114/oj. ↩ ↩²

4. Joint Statement by the Divisions of Corporation Finance, Investment Management, and Trading and Markets, Statement on Tokenized Securities (Jan. 28, 2026), available at https://www.sec.gov/newsroom/speeches-statements/corp-fin-statement-tokenized-securities-012826. ↩ ↩² ↩³ ↩⁴ ↩⁵

5. Securitize Markets BUIDL STEP application (Arbitrum Foundation forum, public), https://forum.arbitrum.foundation/t/securitize-markets-buidl-step-application/23652 (quoted: “U.S. taxable investors will also receive PFIC statements”; describing daily yield accrual at 3:00 PM cutoff with daily in-kind distribution to the holder’s blockchain address per March 20, 2025 update); IRC § 1297, 26 U.S.C. § 1297 (passive foreign investment company definition, including the 75-percent passive-income test and 50-percent passive-asset test). The issuance of PFIC statements is the practitioner signal that a foreign issuer has accepted the default foreign-corporation classification under § 301.7701-3 and operates as a PFIC for U.S. federal income-tax purposes. ↩ ↩² ↩³ ↩⁴

6. F/m Investments, F/m Investments Files First-of-Its-Kind SEC Application for Tokenized ETF Shares (Jan. 21, 2026), available at https://www.fminvest.com/news/fm-investments-files-first-its-kind-sec-application-tokenized-etf-shares. ↩

7. Multi-Class ETF Fund Exemptive Relief Under the Investment Company Act of 1940, 91 Fed. Reg. 2026-08570 (May 4, 2026); see also F/m Investments, F/m Investments Becomes First ETF Issuer to Launch Dual Share Class Fund (Feb. 2026), available at https://www.fminvest.com/news/fm-investments-becomes-first-etf-issuer-launch-dual-share-class-fund. ↩

8. SEC and CFTC, Application of the Federal Securities Laws to Certain Types of Crypto Assets and Certain Transactions Involving Crypto Assets, Release Nos. 33-11412; 34-105020 (Mar. 17, 2026); see also SEC Press Release 2026-30. Direct fetch of the SEC release URL returns 403; the release, the release numbers, and the supersession of the 2019 Framework are cross-confirmed across Davis Polk, Gibson Dunn, Morgan Lewis, Sidley, and Sullivan & Cromwell client publications. ↩ ↩²

9. SEC, Framework for “Investment Contract” Analysis of Digital Assets (Withdrawn), available at https://www.sec.gov/about/divisions-offices/division-corporation-finance/framework-investment-contract-analysis-digital-assets. The page title encodes both the withdrawal status and the cross-reference to the March 17, 2026 release. ↩

10. SEC Division of Investment Management, No-Action Letter to Simpson Thacher & Bartlett LLP (Sept. 30, 2025) (state-chartered trust companies as qualified custodians for “Crypto Assets”); see Morgan Lewis, Crypto Custody Breakthrough: SEC Staff Grants Relief for Registered Funds, Advisers (Oct. 2025), https://www.morganlewis.com/pubs/2025/10/crypto-custody-breakthrough-sec-staff-grants-relief-for-registered-funds-advisers; Sidley Austin LLP, SEC Staff Issues No-Action Relief Permitting Use of State-Chartered Trust Companies (Oct. 2025), https://www.sidley.com/en/insights/newsupdates/2025/10/sec-staff-issues-no-action-relief-permitting-use-of-state-chartered-trust-companies. The quoted scope-limitation language (“does not state that the current custody provisions… would be expanded to include those Crypto Assets not already in scope”) is reproduced from the Morgan Lewis summary, which itself quotes the NAL’s text. ↩ ↩² ↩³

11. Investment Advisers Act Rule 206(4)-2, 17 C.F.R. § 275.206(4)-2 (Custody of Funds or Securities of Clients by Investment Advisers). The qualified-custodian bank category is at § 275.206(4)-2(d)(6)(i), incorporating the bank definition of Investment Advisers Act §202(a)(2), 15 U.S.C. § 80b-2(a)(2). The privately-offered-securities exception is at § 275.206(4)-2(b)(2). Available at https://www.law.cornell.edu/cfr/text/17/275.206(4)-2. ↩ ↩² ↩³ ↩⁴

12. OCC Interpretive Letter 1183 (Mar. 7, 2025), available at https://www.occ.gov/topics/charters-and-licensing/interpretations-and-actions/2025/int1183.pdf (reaffirming IL 1170, IL 1172, and IL 1174; rescinding IL 1179 supervisory non-objection prerequisite); see also OCC Interpretive Letter 1184 (May 7, 2025) (sub-custody guidance); 12 U.S.C. § 24 (Seventh); 12 C.F.R. Part 9 (national-bank fiduciary powers); 12 C.F.R. Part 12 (recordkeeping and confirmation requirements for securities transactions). OCC has not addressed whether tokenized fund shares fall within the “crypto-asset” scope of these letters or are separately authorized under the bank’s general custody and fiduciary powers. ↩

13. Family Office Rule, 17 C.F.R. § 275.202(a)(11)(G)-1 (excluding qualifying family offices from the “investment adviser” definition); Investment Advisers Act §202(a)(11)(G), 15 U.S.C. § 80b-2(a)(11)(G). A family office that does not register as an investment adviser is not subject to Rule 206(4)-2. State-law fiduciary duties (e.g., the Uniform Prudent Investor Act as enacted in the trust’s situs jurisdiction) and the governing trust or partnership instruments supply the operative duties. ↩

14. U.C.C. §§ 8-102(a)(9)(iii), 8-501, 8-503 (2022) (security-entitlement framework; financial-asset election; ring-fence against securities-intermediary creditors), available at https://www.law.cornell.edu/ucc/8; 11 U.S.C. §§ 741-752 (Bankruptcy Code Subchapter III stockbroker-liquidation provisions); Securities Investor Protection Act of 1970, 15 U.S.C. § 78aaa et seq.; SIPC, What SIPC Protects, https://www.sipc.org/for-investors/what-sipc-protects (excluding unregistered investment contracts from SIPA’s “security” definition). ↩ ↩²

15. In re Celsius Network LLC, 647 B.R. 631 (Bankr. S.D.N.Y. 2023) (Glenn, J.) (Earn-program assets property of the estate based on contract terms); see Order, In re Celsius Network LLC, No. 22-10964 (MG) (Bankr. S.D.N.Y. Dec. 20, 2022) (Custody-account assets not property of the estate). Holding verified via Arnold & Porter, Morrison Foerster, and Sidley client alerts. ↩

16. IRC §§ 851, 852, 26 U.S.C. §§ 851, 852 (Subchapter M — definition of regulated investment company; taxation of RICs and their shareholders, including ordinary-income dividends per § 852(b)(2) and capital-gain dividends per § 852(b)(3)). Available at https://www.law.cornell.edu/uscode/text/26/851 and https://www.law.cornell.edu/uscode/text/26/852. ↩ ↩² ↩³ ↩⁴

17. Treas. Reg. § 301.7701-3, 26 C.F.R. § 301.7701-3 (classification of certain business entities; check-the-box election); see also Treas. Reg. § 301.7701-2 (business entities; definitions, including the per-se corporation list at § 301.7701-2(b)(8)). A BVI Limited Company is not on the per-se list and is an eligible foreign entity whose default classification, for an entity of two or more members with no member having unlimited liability, is a foreign corporation. Available at https://www.law.cornell.edu/cfr/text/26/301.7701-3. ↩

18. IRC §§ 1291, 1295, 1296, 1298, 26 U.S.C. §§ 1291, 1295, 1296, 1298 (PFIC excess-distribution regime, interest charge, QEF election, mark-to-market election for marketable stock, and special rules including Form 8621 reporting). The § 1296 mark-to-market election is available only where the PFIC stock is “marketable stock” within § 1296(e), which generally requires regular trading on a qualified exchange or other market; tokens restricted to qualified purchasers under § 3(c)(7) of the Investment Company Act of 1940 and traded only on permissioned platforms are unlikely to satisfy that test. ↩ ↩² ↩³ ↩⁴

19. IRC §§ 701, 704, 7704, 26 U.S.C. §§ 701, 704, 7704 (partner-level taxation; partner’s distributive share; publicly-traded partnerships treated as corporations); Treas. Reg. § 1.7704-1, 26 C.F.R. § 1.7704-1 (publicly-traded-partnership safe harbors, taken up at length in §VI). Available at https://www.law.cornell.edu/cfr/text/26/1.7704-1. ↩ ↩²

20. IRC § 61, 26 U.S.C. § 61 (gross income defined); Rev. Rul. 2023-14, 2023-33 I.R.B. 484 (staking-rewards holding: cash-method taxpayer who stakes cryptocurrency native to a proof-of-stake blockchain and receives additional units as rewards includes fair market value of rewards in gross income in the year of receipt of dominion and control; holding limited to PoS validation rewards on its face); Rev. Rul. 2019-24, 2019-44 I.R.B. 1004 (hard-fork / airdrop treatment; constructive-receipt “dominion and control” principle); Notice 2014-21, 2014-16 I.R.B. 938 (convertible virtual currency treated as property). Practitioner consensus (Cooley, DLA Piper, Fenwick, Norton Rose Fulbright) treats Rev. Rul. 2023-14 as instructive but not controlling for rebase-mechanic analysis; the article adopts the § 61 / Rev. Rul. 2023-14 analog as the safest characterization while acknowledging § 301 / § 1291 as alternative routes for corporate / PFIC issuers. ↩ ↩²

21. IRC § 1256(b)(1), 26 U.S.C. § 1256(b)(1) (enumerating section 1256 contracts: regulated futures contracts; foreign currency contracts; nonequity options; dealer equity options; dealer securities futures contracts — a closed list that does not include tokenized fund shares); IRC § 988, 26 U.S.C. § 988 (treatment of certain foreign-currency transactions; § 988(c)(1) limits the regime to nonfunctional-currency-denominated instruments). U.S.-functional-currency holders of tokens representing claims on USD-denominated assets and receiving USD-equivalent distributions have no § 988 exposure. ↩ ↩²

22. Cal. Rev. & Tax. Code § 23101 (“doing business” definition), available at https://leginfo.legislature.ca.gov/faces/codes_displaySection.xhtml?sectionNum=23101&lawCode=RTC; California Franchise Tax Board, “Doing business in California” guidance (2025 thresholds: $757,070 California sales; $75,707 California real or tangible personal property; $75,707 California compensation paid — inflation-adjusted annually under § 23101(d) by reference to § 17041(h); 2026 thresholds not yet published by FTB as of mid-May 2026). The California Office of Tax Appeals has rejected treating § 23101(b)‘s factor thresholds as a safe harbor: a sub-threshold issuer can still be “doing business” under § 23101(a)‘s broader “actively engaging in any transaction for the purpose of financial or pecuniary gain or profit” test. See CBIZ, California Agency Rules Section 23101(b) Not Safe Harbor, https://www.cbiz.com/insights/article/california-agency-again-rules-that-states-factor-nexus-thresholds-are-not-a-safe-harbor-for-franchise-taxes. ↩

23. Securities Act of 1933 §5, 15 U.S.C. § 77e (prohibiting the offer or sale of any security in interstate commerce absent registration or an applicable exemption); see also Securities Act §2(a)(3), 15 U.S.C. § 77b(a)(3) (defining “sale” and “offer to sell” to include “every contract of sale or disposition of a security or interest in a security, for value” and “every attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security, for value”). The Reg D 506(c) primary-offering exemption (17 C.F.R. § 230.506(c)) operates as the §5 exemption for BUIDL and OUSG; secondary-transfer mechanics rely on the issuer’s transfer-restriction architecture either to make the on-chain transfer not a “sale” (transfer-agent recordation change among holders who qualified for the original Reg D 506(c) offering) or to satisfy a separate resale exemption (e.g., Rule 144, 17 C.F.R. § 230.144). The §IV(D) issuer-side framing carries the operative-theory hook; a deeper §5-secondary-sale analysis (Rule 144 holding-period and Form 144 mechanics for tokenized fund shares; Rule 144A QIB-only universe; §4(a)(7) accredited-resale exemption) is reserved for the forward-series companion piece. ↩

24. IRC § 7704, 26 U.S.C. § 7704 (publicly traded partnerships treated as corporations), available at https://www.law.cornell.edu/uscode/text/26/7704; Treas. Reg. § 1.7704-1, 26 C.F.R. § 1.7704-1 (publicly-traded-partnership safe harbors), available at https://www.law.cornell.edu/cfr/text/26/1.7704-1. Subsection (c) defines “secondary market or substantial equivalent” by reference to features including regular quotations by brokers or dealers, regular public bid-and-offer quotes, or the functional equivalent; subsection (h) is the private-placement safe harbor (all interests issued in transactions not required to be registered under the Securities Act of 1933 and no more than 100 partners during the taxable year); subsection (j) is the de minimis safe harbor for cumulative annual transfers of 2 percent or less of total interests in partnership capital or profits. ↩ ↩² ↩³ ↩⁴ ↩⁵ ↩⁶

25. 17 C.F.R. § 230.506(c) (Reg D Rule 506(c) general-solicitation offering exemption requiring verification of accredited-investor status). The 506(c) / §1.7704-1(h)(1)(i) interaction is genuinely contested; the article’s framing reflects practitioner consensus, not a binding authority on point. ↩

26. Federal Deposit Insurance Act, 12 U.S.C. § 1821(a)(1)(B) (standard maximum deposit insurance amount of $250,000 per depositor per insured depository institution, as raised under the Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, § 335 (2010)), available at https://www.law.cornell.edu/uscode/text/12/1821. ↩