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We’ve discussed how to utilize the Net Unrealized Appreciation (NUA) treatment of distributions from your qualified retirement plan (also known as QRP, meaning 401(k), 403(b), and other plans) – one of the earlier articles on Net Unrealized Appreciation can be found at this link.
Even though the process is explained in the earlier article, we didn’t discuss just what exactly can be treated with the NUA option. How do you determine what part of the distribution can be treated with capital gains treatment?
In order to determine what is to be treated as unrealized appreciation, we need to define what has to be treated as ordinary income from such a distribution. Briefly, the way that the NUA option works is that you take a complete distribution of your QRP account within one tax year – and you have the option to treat a portion of your account distribution with capital gains. The portion that can be treated as capital gains is the amount of growth that has occurred in the value of company stock (your company, the one that you have the retirement plan with).
Not all of the company stock in your account is necessarily available for NUA treatment. This is where we’ll define what cannot be treated in that fashion. The following items cannot be used for NUA, and they make up the basis of the company stock in your account:
- Your contributions to the plan that are attributable to the employer stock
- Your employer’s contributions to the plan, attributable to the employer stock
- The Net Unrealized Appreciation in the stock attributed to employer contributions
Those three items will be taxed as ordinary income in the year that the distribution occurred. So, the only thing that is left, Net Unrealized Appreciation of the company stock purchased with your own contributions, can be taxed with capital gains tax – instead of ordinary income tax, as all other pre-tax distributions from the plan are treated.
This is not an all-or-nothing provision. You have the option to elect NUA treatment for only a portion of your overall distribution from the account. Everything else could be rolled over into another QRP or an IRA, further deferring taxation.
Holding period
The stock distributed from the employer plan that you’ve elected to use NUA treatment on is treated as having been held for greater than one year. Therefore, the growth that is distributed (the NUA) will have the characteristic of long-term capital gains tax treatment. Additional gains beyond the initial NUA have a holding period that begins with the date of distribution – so it could be short-term or long-term capital gains, depending on when you take the distribution.
