Net Unrealized Appreciation – Basis Rollover

Submitted by Nathan Corroy on Fri, 2013-04-26 21:31

When completing a Net Unrealized Appreciation strategy, the value of the employer’s cost basis in the stock is taxable as an ordinary income distribution. Can an individual use cash to complete a “rollover” of this basis amount?

e.g.
401(k) has value of $200K, of which $100K is employer stock with basis of $10K. Under the NUA strategy, individual moves the $100K stock to after-tax account and reports $10K of ordinary income distribution from the basis. Client subsequently deposits $10K of cash to the receiving IRA as a “rollover” and avoids the tax on the $10K basis.

Can you do this?

Code references would be particularly helpful.



Submitted by mk foss on Fri, 2013-04-26 22:28

In Rev. Rul 87-77 an employee was not allowed to retain the property received as a retirement distribtuion and roll over cash equal to the property’s fair market value. That situation is much less egregious than the one yu’re inquiring about. Property (like NUA shares) can either be rolled over directly or sold without recognizing gain or loss and the proceeds rolled over. You can’t merely roll over basis and keep the stock.

Submitted by Alan - IRA critic on Fri, 2013-04-26 23:45

  • With respect to code references, note that Sec 402(e)(4) describes NUA treatment. 402(e)(4) indicates that such treatment does NOT apply to property described in 402(c). 402(c) describes distributions that are rolled over. Therefore any portion of a distribution that is rolled over cannot be used for NUA treatment since the taxable cost basis is part and parcel of NUA treatment.
  • This does not mean that the participant cannot take some of the shares after distribution and apply NUA and roll the rest over to an IRA. The NUA would be limited to the NUA per share of the shares not rolled over and the cost basis would be proportional. For those few plans that account for company shares in different lots with different cost bases, it may be possible to sell the higher cost basis shares in the plan before the LSD and the 1099R would then reflect a higher box 6 NUA amount relative to the Box 1 amount.
  • This topic also brings up the closely related issue of PLR 8538062 under which the IRS allowed the participant to roll over shares to an IRA equal to the aggregate cost basis and apply all the NUA to the remaining shares resulting in the remaining shares having a 0 cost basis. This ruling has been widely disputed over the years and about 10 years ago in an IRS conference the IRS indicated that this ruling would not hold up today. This “strategy” is the same as the example you proposed except that the participant did not roll over cash to the IRA, he rolled over shares equal in value to the cost basis. Considering the typical Form 1040 reporting of an LSD with NUA including an IRA rollover, where the participant’s math is not clearly disclosed, some of these have probably skated through the IRS over time, but current approval of the IRS for this strategy is doubtful as the probability is that the per share cost and NUA amounts cannot be separated from the respective shares.

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