Net Unrealized Appreciation

Net Unrealized Appreciation (NUA) is a tax strategy available to employees who hold appreciated company stock within a 401k-plan or similar retirement account. By distributing the stock in-kind (rather than cashing it out), the employee can defer taxation on the gain and pay capital-gains tax (at favorable rates) only when the stock is eventually sold, rather than ordinary income tax immediately.

An employee accumulates $500,000 in their company’s stock within a 401(k) plan. The stock cost the employer $100,000 to contribute (or the employee to buy through an ESPP); it is now worth $500,000. Normally, withdrawing the $500,000 from the 401(k) triggers ordinary income tax at the employee’s marginal rate—potentially 37% federally plus state tax.

NUA allows an alternative: take a distribution of the stock itself (not the cash), triggering tax only on the cost basis ($100,000) at ordinary rates. The $400,000 unrealized gain is deferred. Later, when the employee sells the stock, the gain is taxed at long-term capital-gains rates (0%, 15%, or 20% federally, plus state tax). The tax is cheaper and deferred.

The NUA calculation

Net Unrealized Appreciation is defined as the difference between the fair market value of the company stock at distribution and the cost basis (the amount the plan paid for the stock or the price at which the employee purchased it, depending on the source).

Example:

• Employee’s 401(k) holds 10,000 shares of employer stock.
• Cost basis of stock in plan: $50 per share = $500,000 total.
• Current market value: $150 per share = $1,500,000 total.
• NUA = $1,500,000 − $500,000 = $1,000,000.

At distribution (separation from service), the employee can elect NUA treatment:

• The $500,000 cost basis is subject to ordinary income tax at the employee’s marginal rate. If the employee is in the 37% bracket, tax is $185,000.
• The $1,000,000 NUA is deferred. When the employee later sells the stock (in a year when they might be in a lower bracket, or after retirement when income is lower), the NUA is taxed as long-term capital gains.

If the employee waited until the next calendar year to sell the stock, selling triggers long-term capital-gains tax on the $1,000,000. In the 20% bracket, that’s $200,000—more than the ordinary income tax on the cost basis alone. But the deferral allows the employee to potentially sell in a lower-income year or time the sale to offset losses elsewhere.

Eligibility and triggering events

NUA is available only to employees who separate from service with the company—due to retirement, termination, death, or (for 5% owners) upon disability. Merely rolling over the 401(k) to another plan forfeits NUA treatment.

The election must be made at the time of distribution. Many plans and custodians have NUA elections on their distribution forms. The election is irrevocable; once made, the NUA treatment applies.

Interaction with RMDs and rollovers

A critical detail: if an employee takes a distribution from their 401(k) and chooses NUA treatment, they cannot roll over the cost basis portion into an IRA without triggering ordinary income tax. The NUA election forces the employee to take a taxable distribution of the cost basis.

Conversely, if an employee wants to roll the full 401(k) balance into an IRA, they forgo NUA treatment. The entire balance becomes an IRA, and subsequent withdrawals are taxed as ordinary income. This is a one-time decision: elect NUA and separate, or roll to IRA and defer/preserve.

For required-minimum-distribution purposes, NUA treatment reduces the size of the 401(k) balance (since the stock is distributed), but the employee must include the cost basis in their taxable income for the distribution year.

Practical scenarios where NUA shines

High ordinary income rate, low expected capital-gains rate. An employee in the 37% bracket takes a distribution of $1M company stock ($500k cost basis, $500k NUA). They pay 37% on the $500k = $185k. If they later sell the stock in a year when they’re retired and in the 15% capital-gains bracket, the $500k NUA is taxed at 15% = $75k. Total tax = $260k. Without NUA, taking the distribution and immediately selling would trigger $1M × 37% = $370k (all ordinary income). NUA saves $110k.

Waiting for a market decline to sell. An employee receives stock at $150/share, with $50/share cost basis. If the stock falls to $100/share before the employee sells, the gain is only $50/share. The employee triggers capital-gains tax on the $50/share × shares NUA (the reduced gain), saving taxes. The cost basis is still taxed at ordinary rates at distribution, but the NUA portion shrinks with the stock price.

Charitable donation. An employee receives the stock via NUA and donates it to a charity immediately after. The donor avoids capital-gains tax on the NUA (charities don’t pay tax) and still claims an income-tax deduction for the full fair market value. This is more tax-efficient than donating appreciated IRA assets, which trigger ordinary income tax on the distribution.

Downsides and risks

No flexibility. Once the stock is in taxable hands, the employee is subject to market and concentration risk. If the stock plummets, the employee has locked in a taxable position.

Ordinary income tax is not deferred, only the NUA. The cost basis is taxed immediately at ordinary rates. Only the gain is deferred. If the ordinary income tax rate is high, this can be expensive.

Complexity. NUA is not well-understood by financial advisors or plan administrators. Many employees and advisors miss the opportunity because they don’t understand the rule or how to elect it.

Market risk on deferred gain. The deferred NUA depends on the stock price when the employee eventually sells. If the stock appreciates further, the employee faces a larger long-term gain and higher tax. If it depreciates, the employee may face a loss—but long-term capital losses can only offset capital gains, with a limit.

Example: NUA in a windfall scenario

A founder holds company stock in a 401(k) and the company is acquired at a significant premium:

• Stock was $50/share; now bid at $200/share.
• Cost basis in plan: $200,000 (4,000 shares × $50).
• Current value: $800,000 (4,000 shares × $200).
• NUA = $600,000.

The founder can elect NUA, pay ordinary income tax on $200,000, and defer tax on the $600,000 gain. If the acquisition is all-cash at $200/share, the founder will sell and trigger long-term capital-gains tax on the $600,000 in the year of sale (or future years if the shares are held outside the plan before sale).

Without NUA, the $800,000 distribution is all ordinary income tax, triggering ~$296,000 in tax (37% bracket). With NUA, the $200,000 basis is ordinary income = $74,000, and the $600,000 NUA is long-term gains = $120,000 (at 20% rate). Total = $194,000. Savings = $102,000.