Net Unrealized Appreciation (NUA) – claiming cost basis

Submitted by Kurt Strullmyer on Tue, 2017-01-31 14:45

I hold publicly traded stock in my 401k with a current market value of $2.2 million. My cost basis is $800k. I understand that I can transfer shares in kind to a brokerage account, recognize taxable income on the cost basis of those shares and then only be subject to long term capital gains on the amount above the basis when I sell the shares. I have come across an article in Forbes magazine from 2012 that is promoting a “Basis Allocation Twist”. Basically the article explains a strategy to first do an IRA rollover of stock totaling the value of the cost basis ($800K). The IRA rollover account will be 100% taxable. Then when the remaining stock is moved from the 401k to the taxable brokerage account, the basis will be $0, therefore eliminating any income tax due and the entire balance held in stock would then be subject to only capital gains. Is this strategy acceptable by the IRS? It seems to contradict everything I have read on process for taking NUA.



Submitted by Alan - IRA critic on Tue, 2017-01-31 16:30

  • This is the “Frank Duke” method. There are a few threads you can pull up by entering Frank Duke into this site’s search box. The most extensive one is here:   https://irahelp.com/forum-post/17504-nua-lsd-401k
  • Bottom line is that the IRS has issued mixed messages on this method as specified in the above link. No doubt a few taxpayers that have applied this strategy in the past were not challenged because the IRS did not know what they were looking at. It is clear that NUA shares can be rolled to an IRA within 60 days, but the IRS still considers the cost basis and NUA to exist per share and not in the aggregate and therefore both cost basis and NUA are being rolled over.
  • A tax code provisions states that when a distribution is made and rolled over, the taxable amounts are considered to be the first dollars rolled over. While the cost basis is clearly a taxable amount, the NUA is also taxable, but not until sold. The Duke strategy depends on this provision, but it is not clear that this provision applies to these shares.
  • Finally, it is useful to consider the potential downside of aggressively reporting the IRA rollover in this fashion and having the IRS reject it. The rollover would still be valid, but you would get a tax bill for about 512k which is 64% of the cost basis. Your cost basis is around 36% of FMV, so you would have rolled over 288k of the 800k cost basis and been taxed on the rest. The rest of the 800 k rolled would be NUA, so your remaining shares in the taxable account would be worth 1.4mm, have a cost basis of 512k and NUA of 888k. Therefore, this would not become the disaster of a fully taxable distribution of 2.2mm, beside late fees on the taxes due you would just end where you would have been had you elected to only take a distribution of 64% of the NUA shares and had you plan roll the rest of the shares over to a TIRA along with the rest of the 401k. The problem is that until the statute of limitations runs out you really would not know where you stand with respect to selling the NUA shares you have in your taxable account, and you might want to diversify out of these shares sooner rather than later.

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