Net Unrealized Appreciation

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L1: Net Unrealized AppreciationI have a 401k at work that included company stock that I purchased. Because of some bad advice, I was told to sell that stock. I am a year away from retirement and now understand that if I would have kept this employer stock, I would have been entitled to some advantageous tax breaks. Is this irreversible? Did I lose this tax benefit forever? Or is there any way that I can reverse this?2010-09-24 21:18, By: Janet, IP: []
L2: Net Unrealized AppreciationUnfortuneatly, there is no way to reverse the sale. But if you sold the shares to properly diversify, you may end up better off. Remember companies like Enron, Worldcom and Lehman Bros that went to near zero in a very short period of time. Too many people areoverloaded with employer stock. If you were to have taken the shares at retirement for NUA purposes, you would have to sell them very soon in order to diversify. But by next year the LT cap gain rate could well be 20% instead of 15%, possibly even higher.
Moreover, if the plan cost basis for your shares is much over 30% of the current value (actually the value upon your retirement), and you do not plan to sell the shares right away, the value of the NUA is diluted by your loss of tax deferral since you must pay the tax on the cost basis in the year of distribution.
While you did lose a potential tax break, there are several scenarios in which you might have been better off not ever utilizing NUA, but if you sold the shares without even investigating the potential value of NUA, the advice was obviously bad. Most people are not aware of NUA and all the rules that go with it, and many tax preparers are also not up to speed on the subject.
Being a year from retirement, you might be able to re purchase the shares in the plan, but they will have a currrent cost basis and one year would normally be far short of the time that you would get enough appreciation for NUA use later on. Of course, you could leave the 401k plan with the employer for an indefinite period and appreciation could continue over that time, but then you might be sacrificing other opportunities. 2010-09-24 22:32, By: Alan S., IP: []

L3: Net Unrealized AppreciationThanks for the response! Another question: I am 50 years old. Assume I dididn’t sell my employer stock. If I retired next year at 51, and if I wanted to take advantage of NUA, would I have to pay the 10% penalty on the basis (as well as the income tax) because I am under 55? I thought I read somewhere that you have to be over 55 to take advantage of NUA to avoid the 10% penalty.2010-09-25 15:04, By: Janet, IP: []

L4: Net Unrealized AppreciationYes, you would have had to pay the penalty on the cost basis unless you met an unrelated penalty exception. That penalty would be waived if you waited to separate in the year you turned 55 or later.
In this case however, the penalty would have applied until age 59.5 since you will separate prior to the year you reach 55. This is another reason why NUA is not worthwhile unless you have a low cost basis.
That said, you do not have to take the LSD required to use NUA right after separation. You could leave the plan intact until you reached 59.5 as attainment of age 59.5 is another “triggering event” which means that you could still use NUA even if you took an intervening distribution earlier. Without a new triggering event, the intervening distribution disqualifies use of NUA.
So you could actually repurchase the stock in the plan before you retire and leave the stock in the plan. By the time you reached 59.5 if the shares did real well you could take your LSD then and there also would be no early withdrawal penalty on the cost basis. When everything is considered this would likely not be a good idea in most cases, but if you were absolutely convinced that this company’s stock was going to riseby a large amountin 9 years and you were sufficiently diversified, you could consider it.
Good chance that both marginal tax rates and LT cap gain rates will be higher by then, actually higher within the next couple of years.2010-09-25 18:11, By: Alan S., IP: []

L5: Net Unrealized AppreciationCLARIFICATION You do not have to sell your NUA shares after distribution in order to diversify. I had a client establish his regular non-retirement account as a MARGIN ACCOUNT. Because he needed cash flow, but did not want to diversify at that time, he was able to take money from that account TAX-FREE during the initial calendar year because he had a large salary and severence that year. When he was ready to diversify, but not pay taxes, he merely bought other stocks on margin.
By the way, the sale of NUA stock is all Long-Term Capital Gain ( even the day after retiring), at preferential tax rates, much lower than the regular tax rates on retirement plan distributions.2010-09-28 05:12, By: dlzallestaxes, IP: []

L6: Net Unrealized AppreciationNote that any gains in the NUA shares incurredAFTER distribution are taxed at the higher ST cap gain rate if the shares are sold in the first year. After one year, all gains are LT.2010-09-28 20:03, By: Alan S., IP: []

1. The appreciation up to the date of the distribution is taxable at LONG-TERM capital gains tax rates.
2. Any ADDITIONAL appreciation from that dateif sold before1 year later is taxed at SHORT-TERM capital gains tax rates.
3. Any DECLINE in value if sold within that firstyear is deductible at SHORT-TERM capital loss rates which are the regular ordinary income tax rates.
4. All ADDITIONAL appreciationfrom that date if sold after 1 year later is taxed at LONG-TERM capital gains tax rates.2010-09-28 20:37, By: dlzallestaxes, IP: []

L8: Net Unrealized AppreciationDLZ,
Agree with 1, 2 and 4.
Re Point 3: Do not agree with this one unless you assume a decline large enough to erase all the NUA and then fall below the cost basis at distribution. This is possible, but unlikely unless taxpayer is asleep at the switch.
Example: Cost basis per share 8.00; FMV 25.00.
If stock sold within a year for 20.00, report a LT gain of 12.00 on Sch D
If stock sold within a year for 6.00, all NUA is gone and report a LT loss of 2.00 per share on Sch D.
In summary, there would have to be a huge decline to actually fall below the cost basis since most NUA distributions are done when the FMV is at least 3 times the cost basis.
2010-09-29 03:44, By: Alan S., IP: []

L9: Net Unrealized AppreciationAlan is correct re #3. I typed without thinking it thru. Sorry for misinformation.2010-09-29 04:43, By: dlzallestaxes, IP: []