Net Unrealized Appreciation: The One-Shot Decision at Separation

If you hold appreciated employer stock inside your 401(k), stop before you roll the account anywhere. IRC §402(e)(4), “Taxability of beneficiary of employees’ trust” offers a treatment available exactly once, at a triggering event, and destroyed permanently by the reflexive rollover-to-IRA that most people execute in their first week of retirement.

The mechanics: on a lump-sum distribution of your entire plan balance following separation from service, death, or reaching 59½— or disability, but only for a self-employed participant — you may distribute the employer stock in kind to a taxable brokerage account. You pay ordinary income tax that year on the shares’ cost basis only — what the plan paid for them. The net unrealized appreciation, the entire gain above that basis, is not taxed at distribution. It is taxed at long-term capital gains rates whenever you eventually sell, automatically long-term regardless of how long you actually hold, and it never becomes an RMD.

Size it before you decide. Let $B$ be the basis, $V$ the market value, ${\tau }_o$ your ordinary rate, and ${\tau }_{\mathit{cg}}$ your long-term rate. The NUA route costs $B{\tau }_o$ now and $(V-B){\tau }_{\mathit{cg}}$ later; the rollover route costs $V{\tau }_o$ whenever the money comes out. NUA wins when

which is always true on paper — so the sign of that inequality decides nothing. The real decision variables are the basis ratio, because the basis is the slice taxed immediately, and the deferral you give up: the NUA route hands the IRS $B{\tau }_o$ this year, while the rollover defers its entire $V{\tau }_o$ until withdrawal, and a tax dollar deferred $n$ years costs only ${(1+r)}^{-n}$ of a tax dollar paid today. Concretely: $1M of company stock with a $150,000 basis, at 40.8% ordinary and 23.8% long-term, costs $\$150,000\times 40.8\%=\$61,200$ today plus $\$850,000\times 23.8\%=\$202,300$ on sale — $263,500 against $408,000 if the whole position rolls to an IRA and comes out as ordinary income. A $144,500 swing on one election. Reverse the basis ratio — $850,000 of basis on $1M of value — and NUA still “wins” the static ledger, $382,500 against $408,000, but now $346,800 of it is due immediately while the rollover’s $408,000 sits at withdrawal, perhaps fifteen years out; at a 6% discount rate that deferred bill is worth about $170,000 today, and the rollover wins decisively. So discount every tax payment to present value at your expected return before electing. The NUA edge is real when the basis ratio is low and you would be spending the money soon anyway; it evaporates when the basis ratio is high or the IRA could compound untouched for decades.

The rules that trip people:

It must be a lump-sum distribution

The entire balance in all like plans must leave within a single tax year. Take a partial distribution first, or roll part of it, and the election is gone for that triggering event.

Cash can still roll over

You may direct the non-stock portion of the plan to an IRA and take only the employer stock in kind. The lump-sum requirement is about emptying the plan, not about taking everything in cash.

The rollover is irreversible

Employer stock moved into an IRA converts its entire value to future ordinary income. There is no undo, and no custodian will warn you.

Post-distribution appreciation is ordinary holding-period stock

Gain above the distribution-date value follows normal short/long rules from the distribution date; only the NUA itself is automatically long-term.

Under 59½, the basis draws a 10% penalty

The IRC §72(t), “Annuities; certain proceeds of endowment and life insurance contracts” penalty hits only the taxable basis; the NUA itself escapes penalty entirely. The rule-of-55 separation exception of IRC §72(t)(2)(A)(v) can cover it.

It is concentration risk by construction

The strategy works by keeping a large single-stock position in taxable. Pair it with the diversification tools in section “Concentrated Stock Positions” instead of treating the tax break as an excuse to hold a concentrated bet indefinitely.

The bequest angle sharpens it further. NUA does not receive a basis step-up at death — your heirs inherit the NUA as income in respect of a decedent and pay long-term rates on it — but any appreciation after the distribution does step up. That makes the shares a reasonable charitable-gift candidate and a poor one to hold to death purely for step-up.