How Is Net Unrealized Appreciation (NUA) Taxed?

Net unrealized appreciation (NUA) tax treatment refers to the taxation of gains on employer stock within a retirement plan when the stock is moved to a taxable account or distributed as a lump sum. Rather than taxing the entire value of the stock as ordinary income, only the original cost basis is subject to income tax, while the appreciation is taxed at long-term capital gains rates. This approach can reduce tax liability for individuals who qualify, offering a potential benefit when distributing company stock as part of retirement planning.

You may want to talk to a professional financial advisor before doing anything that could trigger a tax event.

What Is Net Unrealized Appreciation?

Under ordinary circumstances, when you take distributions from a tax-deferred retirement account like a 401(k), the IRS taxes this money as ordinary income. This applies to both the original value of the assets, known as the “cost basis,” as well as their total gains, known as the “appreciation.”

For example, say that you receive 1,000 shares of your company’s stock in your 401(k). At $10 per share, the stock is worth $10,000 at the time you get it. This is your cost basis. Years later, those shares have increased in value and are now worth $100,000. The $90,000 difference is their appreciation.

Typically, distributions from retirement accounts are taxed as ordinary income. But net unrealized appreciation applies the more favorable long-term capital gains tax rates to the appreciation of company stock owned within the employer’s retirement plan.

You may be able to take advantage of this tax incentive under the following circumstances:

• You have an employer-sponsored retirement account
• The account must hold securities issued by this employer
• The account must be a pretax account – not an after-tax Roth account
• You must be a current or former employee of the employer

As a result, you cannot apply net unrealized appreciation to an IRA, even if you hold your employer’s stock in that account. You also cannot you apply it to unrelated assets that you hold in a qualifying, employer-sponsored plan.

How Does Net Unrealized Appreciation Work?

If you have qualifying employer assets in a qualifying retirement plan, you can take advantage of net unrealized appreciation. Under this tax approach, you would shift your company stock from your retirement account into a taxable brokerage account. The IRS would tax the cost basis of the shares at your ordinary income tax rate, but it would tax any appreciation that occurred at the lower capital gains rate.

Take our example above. Say that during your working life, your employer contributed 1,000 shares of stock worth $10 each into your 401(k). Those shares have now appreciated to $100,000. As discussed below, you can move those shares from your 401(k) to a taxable brokerage account.

If you’re in the 22% income tax bracket, you would pay $2,200 in income tax on the $10,000 cost basis when the shares are distributed. However, when you sell the shares later on, the $90,000 in growth would be taxed at your capital gains tax rate (15%). As a result, you would pay just $13,500 in the capital gains tax on the appreciation, for a total tax bill of $15,700.

On the other hand, if you roll the shares into an IRA, net unrealized appreciation doesn’t apply. All of the stock would be taxed as ordinary income when it’s eventually sold and distributed from the account. That means your tax bill would be $22,000, since the entire position is taxed at 22%.

How Do You Use Net Unrealized Appreciation?

Taking net unrealized appreciation is somewhat complicated. Here are the four things that you need to know about this type of transaction:

1. A “Triggering Event” Must Occur

First, you must have what is called a “triggering event.” This means an event that allows or requires you to change the nature of your 401(k) or other employer-sponsored retirement plan. Most of the time this means leaving your employer, either because of retirement, termination or resignation. Death, qualifying disability or retirement eligibility (turning 59 ½ years old) also apply. 

2. Move Assets to Your 401(k)

Second, once the triggering event has occurred you must move the assets in your 401(k). Typically this means transferring your assets into a new employer-sponsored 401(k) or shifting them into an IRA if you have entered retirement and begun taking distributions. 

This is important because a net unrealized appreciation must be taken all at once. You cannot parcel your shares out over time. Nor can you unring this bell. When you restructure a retirement portfolio after a triggering event, you must decide in that tax year to take any net unrealized appreciation that you want to claim and you must do so all at once. 

3. Move Assets From Your Employer’s Plan

Third, you must move the assets from an employer-sponsored retirement account into a taxable portfolio. To claim the tax benefits of net unrealized appreciation, you cannot move your assets from one tax-advantaged account into another. So, for example, you cannot roll these shares over to a new 401(k) or an IRA and preserve the NUA treatment. You must place them in an ordinary investment portfolio or cash them out. . As we wrote on the subject: 

4. Pay Income Taxes

Finally, you must pay income taxes on the assets that you move. When you move company stock from a retirement account into a taxable account, the IRS considers it a retirement account distribution. They will then tax you on the value of that distribution, applying it to your taxable income for the year in which you take that distribution. The point of net unrealized appreciation is that they will not tax you on the current market value of that distribution, though, just its cost basis. 

For example, say that you want to take a net unrealized appreciation on the $100,000 worth of company stock in our example above. At retirement, you begin restructuring your 401(k) plan to take distributions from it.

You would take the 1,000 shares of stock in your former employer and move them to a taxable brokerage account that you have set up for this purpose. The IRS would consider this a distribution from your retirement account and would charge you income taxes on the value of that distribution. They would tax you on the cost basis of those stocks, so you would add $10,000 to your taxable income for the year.

Bottom Line

Net unrealized appreciation is a way of shifting some of your retirement portfolios from income taxes to capital gains taxes. It applies only to employer-sponsored, pretax retirement accounts and only to securities issued by the employer itself. However, if you qualify, it can save you real money on your taxes.

Retirement Tax Planning Tips

• It’s just as important to stay on top of your taxes in retirement. While there’s no one-size-fits-all answer out there, consider a few of these strategies when you’re making your own long-term plans.
• A financial advisor can help you build a comprehensive retirement plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

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