Net unrealized appreciation, or NUA, is the difference between what your employer’s retirement plan originally paid for company stock held in your account and what those shares are worth today. Federal tax law lets you peel that growth off from the original cost when you take a lump-sum distribution from a qualified plan, so the appreciation is taxed at long-term capital gains rates instead of the ordinary income rates that normally apply to retirement withdrawals.1Office of the Law Revision Counsel. 26 USC 402 – Taxability of Beneficiary of Employees Trust For someone sitting on a large position in highly appreciated employer stock inside a 401(k), the savings can be significant.
How the Tax Split Works
A distribution using the NUA election has two parts. The cost basis — the average price the plan paid for the shares on your behalf — is taxed as ordinary income in the year of distribution. The appreciation above that basis is excluded from current income and deferred until you sell the shares, at which point it qualifies for long-term capital gains rates regardless of how long you personally held the stock after distribution.2Internal Revenue Service. Publication 575, Pension and Annuity Income
Long-term capital gains are taxed at 0%, 15%, or 20% depending on taxable income and filing status, well below the top ordinary rate of 37%. For 2026, single filers pay 0% on long-term gains up to $49,450 of taxable income, and the 20% rate starts above $545,500. Married couples filing jointly reach the 20% bracket at $613,700.
Compare that to the alternative. Roll the stock into an IRA along with everything else, and every dollar you eventually pull out is ordinary income. The NUA election trades a smaller ordinary-income hit today (on the basis alone) for capital gains treatment on the much larger appreciation piece later.
Who Can Use the NUA Election
The tax break is available only when the distribution qualifies as a “lump-sum distribution” under the tax code. That requires two things: a triggering event and a properly structured distribution.
The triggering events are:1Office of the Law Revision Counsel. 26 USC 402 – Taxability of Beneficiary of Employees Trust
- Separation from service through resignation, termination, or retirement. This applies to common-law employees, not self-employed individuals.
- Reaching age 59½, whether or not you have left the employer.
- Disability, for self-employed plan participants who are totally and permanently disabled.
- Death, in which case beneficiaries can use the strategy on inherited employer stock.
The distribution itself must move the entire balance to your credit out of the plan within a single tax year.2Internal Revenue Service. Publication 575, Pension and Annuity Income “Entire balance” is read across plans of the same type. The IRS groups pension plans together, profit-sharing plans (including most 401(k) plans) together, and stock bonus plans together. If your employer runs two profit-sharing plans and you have money in both, both have to be emptied in the same calendar year.
The destinations can differ. The standard approach sends the employer stock in-kind to a taxable brokerage account, preserving NUA treatment, while the rest of the assets (cash, mutual funds, bonds) roll over to a traditional IRA to stay tax-deferred. Missing the one-year deadline, or leaving a balance behind in a like-kind plan, disqualifies the election and turns the whole distribution into ordinary income.
Choosing Which Shares to Elect
You are not forced to apply NUA treatment to every share. Under Treasury Regulation 1.402(a)-1(b)(2)(ii)(A), you can pick which shares go to the taxable brokerage and which roll to the IRA. The math favors electing the lowest-basis shares, because those have the highest ratio of untaxed appreciation and therefore the biggest payoff from capital gains treatment.
Cherry-picking requires that your plan administrator track cost basis lot by lot. Some administrators only report an average across all shares. Ask early. If only an average is available, you can still use NUA, but you lose the ability to target the most appreciated shares.
The 10% Early Withdrawal Penalty
If you take the distribution before age 59½, the 10% early withdrawal penalty generally applies to the taxable portion — the cost basis of the employer stock, plus any non-stock assets you don’t roll over. The NUA amount itself escapes the penalty because it is not part of current-year income.3Internal Revenue Service. Topic No. 412, Lump-Sum Distributions
There is a useful exception. If you separate from service during or after the year you turn 55, the 10% penalty does not apply to distributions from that employer’s qualified plan. For qualified public safety employees of a state or local government, and for private-sector firefighters, the threshold drops to 50.4Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions These exceptions apply only to employer-sponsored plans, not IRAs. That is another argument for the NUA route over a straight IRA rollover if you are retiring in your mid-50s with company stock.
Withholding You Should Know About Before You File Paperwork
If the distribution is entirely in company stock with no cash, no federal tax withholding is required. If it includes both cash and stock, mandatory 20% federal withholding applies to the taxable cash portion.3Internal Revenue Service. Topic No. 412, Lump-Sum Distributions The withholding is calculated on the taxable amount excluding the NUA, but it can only come from the cash side; the custodian will not sell shares to cover it. Confirm the structure with the plan custodian and the receiving brokerage before submitting paperwork so cash withholding does not eat into what you planned to roll into an IRA.
What You Will See on Form 1099-R
After the distribution year closes, you will receive Form 1099-R. Three boxes matter for an NUA distribution:5Internal Revenue Service. Instructions for Forms 1099-R and 5498
- Box 1, Gross Distribution, shows the total fair market value of everything distributed, including the NUA.
- Box 2a, Taxable Amount, shows what is subject to ordinary income tax this year. For a properly reported NUA distribution, that figure excludes the NUA, so it reflects the cost basis of the stock plus any other taxable amounts.
- Box 6, Net Unrealized Appreciation, shows the NUA in employer securities. It is included in Box 1 but excluded from Box 2a, and it is not taxed until you sell the shares.
The Box 2a figure lands on your return as ordinary income. The Box 6 figure sits deferred until you sell, at which point it goes on your return as a long-term capital gain.
Gains After the Shares Leave the Plan
Once the stock is sitting in your taxable brokerage account, two different layers of gain can exist when you eventually sell. The original NUA is always taxed at long-term capital gains rates, no matter how quickly you sell.6Internal Revenue Service. Net Unrealized Appreciation in Employer Securities Notice 98-24 Any further appreciation that happens after the distribution follows the normal holding-period rules: short-term if you sell within a year of the distribution date, long-term if you hold longer.
High earners face one more layer. The 3.8% net investment income tax (NIIT) does not generally apply to the NUA itself, but it does apply to post-distribution appreciation, and it kicks in when modified adjusted gross income exceeds $200,000 (single) or $250,000 (married filing jointly). Selling quickly caps the post-distribution gain; holding builds it.
What Happens if You Hold NUA Stock Until Death
NUA stock is a well-known exception to the step-up in basis rule. Most inherited assets have their cost basis reset to fair market value at the date of death, wiping out unrealized gains for heirs. The NUA portion does not get that step-up: heirs will owe long-term capital gains tax on it when they sell. Any appreciation that occurred after the stock was distributed from the plan does receive a step-up, and the original cost basis portion is no longer an ordinary-income item because it was already taxed at distribution.
The upshot is that holding NUA stock to the grave preserves less of its tax advantage than holding other appreciated securities. Anyone with a large NUA position needs to weigh selling during life at their own capital gains rate against passing the NUA liability to heirs.
State Taxes Can Change the Math
The NUA analysis so far is federal. States vary. Several have no income tax, so both the basis and any gains escape state-level tax entirely. Most states that do levy an income tax treat long-term capital gains the same as ordinary income, which shrinks the state-level benefit of the election. A handful offer preferential rates or partial exclusions for capital gains. Your state’s treatment can shift whether NUA actually saves you money compared with a plain IRA rollover, so run the numbers with state rates in the picture.