Net Unrealized Appreciation

Course: Retirement Planning
Lesson 7: Income Distribution Planning for Qualified Plans

Student Question:

Regarding net unrealized appreciation, the value of company shares at the time of distribution would be considered the client’s cost basis in that any earnings in excess of that amount could be subject to short-term cap gains if sold within a year of the lump sum distribution? At the same time, the growth in share value from the original contributions until the lump sum distribution would be taxed at the long-term capital gains rate?

Instructor Response:

Great question! You’re close and I need only to emphasize a few points.   

The client’s cost basis is the amount of ordinary income that they must recognize when the shares are distributed as part of the lump sum distribution of the client’s entire account balance from the qualified plan (QP).  Here’s how that works:

  • When the shares were originally contributed to the QP by the employer, the employer took an income tax deduction equal to the fair market value of the shares when contributed,  
  • The amount of the employer’s tax deduction must generally be recognized by the client as ordinary income when the shares are distributed to the client from the QP,   
  • The client’s income tax basis in the NUA shares equals the ordinary income recognized by the client, and
  • The NUA is not added to the client’s tax basis in the shares when the shares are distributed to the client.

When the client sells the “NUA” shares, the NUA gain is automatically recognized as long-term capital gain. That’s true even if the client sells the “NUA” shares the day after receiving them from the QP.  You are 100% correct in post-distribution appreciation.  Appreciation in the NUA shares after being distributed to the client will be taxed as either long term or short-term capital gain, depending upon the post-distribution holding period.