The net unrealized appreciation rules let you pull employer stock out of a 401(k) or similar qualified plan and pay long-term capital gains rates on the built-up appreciation, rather than ordinary income rates on the whole distribution. The trade-off is strict: you have to satisfy a qualifying event, empty the plan in a single tax year, and move the shares in-kind to a taxable brokerage account. Miss any of those, and the tax break disappears.
What the Strategy Does
A normal 401(k) distribution is taxed as ordinary income on every dollar. IRC § 402(e)(4)(B) carves out an exception for employer securities: on a qualifying lump-sum distribution, the net unrealized appreciation on those shares is excluded from gross income at the time of the distribution.1Office of the Law Revision Counsel. 26 USC 402 – Taxability of Beneficiary of Employees Trust You pay ordinary income tax only on the plan’s original cost basis for the shares. The NUA, meaning the difference between the plan’s cost basis and the fair market value on the distribution date, is taxed at long-term capital gains rates whenever you sell, no matter how briefly you have held the shares outside the plan.
Any additional gain that accumulates after the shares reach your taxable account follows ordinary holding-period rules. Sell within a year of the distribution and that extra layer is short-term capital gain taxed at ordinary rates; hold longer than a year and it qualifies as long-term. The NUA portion always gets long-term treatment. The spread that makes this worth doing is large: for 2026, the top ordinary income rate is 39.6 percent while the highest long-term capital gains rate is 20 percent.
What Counts as Employer Securities
The statute is narrow. Eligible assets are shares of stock and bonds or debentures issued by the employer corporation, including its parent and subsidiary companies, held inside a qualified plan such as a 401(k) or an Employee Stock Ownership Plan.2Office of the Law Revision Counsel. 26 US Code 402 – Taxability of Beneficiary of Employees Trust3Internal Revenue Service. Employee Stock Ownership Plans
Company stock you bought through a personal brokerage account does not qualify. Neither does employer stock sitting in an IRA. If you roll employer shares from a 401(k) into a rollover IRA before electing NUA, you permanently forfeit the NUA benefit on those shares. The stock has to move directly from the qualified plan into a taxable brokerage account to keep its NUA character.
The Four Triggering Events
You cannot elect NUA on demand. The distribution has to follow one of four events recognized under IRC § 402(e)(4)(D):4Internal Revenue Service. IRS Letter Ruling 200410023
- Reaching age 59½.
- Separation from service through resignation, termination, or retirement (employees only, not self-employed participants).
- Total and permanent disability, available only to self-employed participants.
- Death, allowing a beneficiary to use NUA treatment after the participant dies.
At least one of these must happen before the plan distributes the stock. The event opens the window; it does not force immediate action. But once you decide to act, the distribution has to be completed within a single tax year.
The Lump-Sum Distribution Requirement
This is where most NUA attempts fall apart. The IRS defines a lump-sum distribution as the distribution of the participant’s entire balance from all of the employer’s qualified plans of one kind within a single tax year.5Internal Revenue Service. Topic No. 412, Lump-Sum Distributions “All of the employer’s qualified plans of one kind” is the phrase that catches people. If you have two 401(k)-type plans with the same employer, both must be emptied in the same calendar year.
The employer stock moves to a taxable brokerage account through an in-kind transfer, meaning the actual shares transfer without being sold. Cash, mutual funds, and other non-employer assets in the plan are typically rolled into a traditional IRA so those amounts are not taxed immediately. Everything has to clear the plan by December 31 of the distribution year. If any residual balance remains, the entire NUA election fails and the distribution is taxed as ordinary income.
Partial Elections Within the Same Distribution
You do not have to apply NUA treatment to every share. If your plan tracks individual stock lots with different purchase dates and costs, you can pick specific lots for NUA and roll the rest into an IRA. Lots with the lowest basis and largest appreciation are the best candidates, because you want the capital-gains-taxed portion to be as large as possible relative to the ordinary-income-taxed cost basis.
This flexibility sits inside the lump-sum rule, not around it. You still have to empty the plan entirely within one tax year. The choice is over which shares transfer in-kind to the brokerage account and which shares roll to an IRA, not over what stays behind.
Early Withdrawal Penalty and the Net Investment Income Tax
If you take an NUA distribution before age 59½, the 10 percent early withdrawal penalty applies to the cost basis portion that hits your return as ordinary income. There is a meaningful exception: if you have separated from service in or after the year you turn 55, the penalty does not apply. That makes NUA workable for people retiring in their mid-to-late fifties who want to access employer stock without the penalty stacked on top of the income tax.
The 3.8 percent net investment income tax is the other one to watch. The NUA itself is not treated as net investment income, so it escapes the surtax. Post-distribution growth on the shares after they land in your taxable account is investment income, though, and can be subject to the 3.8 percent tax if your modified adjusted gross income exceeds the applicable threshold.
When NUA May Not Pay Off
The strategy works best when the cost basis is low relative to the stock’s current value, so most of the value gets capital gains treatment and only a small slice gets taxed as ordinary income. When basis is a large share of the current value, the savings shrink.
Expected retirement income matters too. If your income will drop sharply once you stop working, rolling everything into a traditional IRA and drawing it out later at a lower ordinary rate can beat NUA. Someone whose retirement bracket sits around 15 percent gets little benefit from shifting gains into the 15 percent capital gains bracket.
Concentration risk is the practical concern. Electing NUA leaves you holding a large single-stock position in a taxable account. If that stake represents an uncomfortable share of your net worth, the diversification you gain by rolling to an IRA can outweigh the tax savings.
Reporting on Form 1099-R
After the distribution, the plan sponsor issues Form 1099-R. Box 1 reports the total distribution amount, including the NUA. Box 6 identifies the NUA in employer securities specifically.6Internal Revenue Service. Instructions for Forms 1099-R and 5498 (2025) Box 7 carries a distribution code that tells the IRS what type of payout occurred.
On your return, Box 1 minus Box 6 is reported as ordinary income. The Box 6 amount is not included in taxable income that year; you track it as a deferred capital gain that becomes taxable when you sell. Keep the 1099-R and your own basis records indefinitely. If the IRS later questions the capital gains treatment on a sale, you will need to document the NUA amount and the original distribution.
Beneficiaries After the Participant’s Death
Because death is one of the four qualifying events, a beneficiary can execute the NUA strategy after a participant dies. The beneficiary still has to satisfy the lump-sum distribution requirement within a single tax year. Done correctly, the NUA portion keeps its long-term capital gains character in the beneficiary’s hands.
Beneficiaries do not receive a step-up in basis on the NUA portion. The appreciation that built up inside the plan retains its NUA designation and is taxed at capital gains rates when sold. The cost basis portion may receive a step-up depending on how the distribution is handled and reported, but the NUA amount does not benefit from the step-up rules that apply to most inherited assets. And if the lump-sum distribution is botched, the entire amount is taxed as ordinary income to the beneficiary, and the NUA benefit is gone.