What Does Net Unrealized Appreciation Mean?
The net unrealized appreciation (NUA) is the difference in value between the average cost basis of shares and the current market value of the shares held in a tax-deferred account. The NUA is important if you are distributing highly appreciated company stock from your tax-deferred employer-sponsored retirement plan, such as a 401(k).
Understanding Net Unrealized Appreciation (NUA)
Upon the distribution of stock, the NUA is not subject to ordinary income tax. For this reason, it could be better to transfer the company stock to a regular brokerage account instead of rolling the stock over into a tax-deferred IRA. If rolled over to an IRA, the IRS would eventually tax the stock's NUA at your ordinary income tax rate.
The NUA is only available when the stock is originally placed into a tax-deferred account, such as a 401K(k) or traditional IRA, and is only applicable to the stock of the company for which you are or were employed. Roth IRAs do not qualify for NUA because they are not tax-deferred, and brokerage accounts do not qualify for NUA because they are generally subject to the capital gains tax.
Distributing stock out of a 401(k) in a taxable account, such as a brokerage account, will have different effects on NUA funds, per IRS rules and regulations. While the IRS will tax the majority of a 401(k) portfolio at market value in regards to income, shares of the company stock will only be charged as income on the cost basis. This means that any additional value gained since the stock was initially purchased is not taxed as income at this point.
Upon selling the company stock, the NUA will be subject to the capital gains tax, which may be dramatically lower than your current income tax rate, even when a Medicare surtax is added. In cases where it is lower, moving the shares to a taxable account may result in significant tax savings. In cases where the capital gains tax is higher, you may want to distribute the funds in an alternative manner.
Additional Qualifications and Net Unrealized Appreciation
There are additional requirements that must be met as part of the NUA rules. First, within one year, you must distribute the entirety of the vested balance held in the plan, including all assets from all of the accounts sponsored by the same employer. All distributions must be taken as shares and cannot be converted to cash at this time. You must have either separated from the company, reached the minimum age for distribution, suffered an injury resulting in total disability, or you must have died.