Net Unrealized Appreciation (NUA): Definition and Tax Treatment

What Is Net Unrealized Appreciation?

Net unrealized appreciation (NUA) is the difference in value between the average cost basis of shares of employer stock and the current market value of the shares. NUA is important if you move or sell appreciated employer stock from your tax-deferred retirement plan.

Understanding Net Unrealized Appreciation (NUA)

Typically, distributions from tax-deferred retirement accounts are treated as ordinary income at the time of distribution. Ordinary income is taxed at a higher rate than long-term capital gains. To remedy this issue, the Internal Revenue Service (IRS) offers an election for the NUA of employer stock to be taxed at the more favorable capital gains rate.

The NUA election is only available when the stock is placed into an employer-sponsored retirement account, such as a 401(k), and is only applicable to the stock of the company for which you were employed.

Advantages and Disadvantages of Net Unrealized Appreciation (NUA)

When a former employer’s stock is pulled out of a 401(k) plan as part of a lump sum distribution, the NUA is deferred until you sell the stock. This tax deferral can be used in tax strategies, such as transferring the shares to your brokerage account and holding them to defer the tax.

If the stock is not part of a lump sum distribution, taxes on the NUA are not deferred, except for any NUA that results from nondeductible contributions. The rest is taxed as ordinary income in the year you took the distribution.

So, the main disadvantage of NUA tax treatments is that you need to withdraw the stocks in a lump sum to qualify for the tax deferral and then have a plan to place them somewhere to take advantage of it.

Requirements for Net Unrealized Appreciation

There are additional requirements that must be met as part of the NUA rules. Within one year, you must distribute the entirety of the vested balance held in the retirement plan, including all assets from all of the accounts sponsored by the same employer.

Certain qualifying events must also be met. You must have either separated from the company, reached the minimum retirement age for disability, or suffered an injury resulting in total disability (if self-employed). Lastly, if you die, your beneficiaries can qualify for NUA tax deferral for the stocks in the plan.

NUA Tax Options

You have several options when it comes to determining how to take advantage of the NUA rules. Here are a few examples: Imagine you have 100 shares of company stock worth $500 per share in your 401(k), all acquired on the same day at the same price ($50,000). When you left that company a few years later, you were in the 24% tax bracket, married, filing jointly, and planning to retire with an annual income of $70,000. Share values ​​had increased to $550 per share, resulting in a total value of $55,000. You could:

• Cash Out the Stock: Take out the stocks in a lump sum distribution and sell them. Your basis was $50,000, and the current value is $55,000. Your NUA is $5,000, taxed at a capital gains rate of 15%, and the basis is taxed at your income tax rate. Your total tax would be ($5,000 x 0.15) + ($50,000 x 0.24) = $750 + $12,000, or $12,750.
• Roll the Stock Into a Traditional IRA: Taxes are deferred until the stock is sold, and NUA rules don’t apply because the IRA is already tax-deferred: the sale is treated as income. You withdraw and sell the stocks a few years after you roll them over for $65,000, but you’ve retired, and your income tax rate dropped to 22%. Your tax would be $65,000 x .22 = or $14,300.
• Transfer the Stocks to Your Brokerage Account: Take a lump sum distribution of the stocks and place them in your brokerage account. You’re taxed on the stock’s basis ($50,000) at 24%, and the NUA is deferred. You get $12,000 at distribution time. When you sell the stocks a few years later, they might have appreciated to a total of $65,000, increasing your NUA to $15,000 ($65,000 – $50,000). The NUA is taxed at your capital gains rate, but since you’re married, filing jointly, and have a retired income of less than $94,050 (using tax 2024 brackets), you owe no capital gains taxes on the NUA.

The Bottom Line

Net unrealized appreciation is the difference in value between the average cost basis of shares of employer stock and their current market value when held in an employer-sponsored retirement account. Taxes on NUA are generally deferred upon distribution, but taxes on the stocks are not.