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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) 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, $τ_{o}$ your ordinary rate, and $τ_{cg}$ your long-term rate. The NUA route costs $B τ_{o}$ now and $(V - B) τ_{cg}$ later; the rollover route costs $V τ_{o}$ whenever the money comes out. NUA wins when

B τ_{o} + (V - B) τ_{cg} < V τ_{o} ⟺ \frac{B}{V} < 1

which is always true on paper — so the real question is the basis ratio and the deferral you give up. 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 the immediate tax bill swamps the benefit and the rollover wins.

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 penalty applies to the taxable basis amount, not to the NUA. The rule-of-55 separation exception 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” rather than treating the tax saving as a reason to hold forever.

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.

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