He Inherited 8,000 IBM Shares Worth Nearly $2 Million at 52. The Often Overlooked IRS Rule That Decides Whether Most of It Is Taxed as Income or a Capital Gain

If your parent left you a 401(k) full of company stock, the default paperwork could cost you a fortune. A little-known IRS rule called net unrealized appreciation (NUA) lets an heir take employer stock out of an inherited 401(k) and pay capital gains tax on most of it instead of ordinary income tax. Most heirs never hear about it until the money has already moved.

A Hypothetical $2 Million Inheritance Inside a 401(k)

This example is hypothetical. It exists to show how the rule works. A son, 52, is the named beneficiary of his late father’s 401(k). The father spent 33 years as a systems engineer at IBM (NYSE:IBM | IBM Price Prediction) and bought IBM stock inside the plan throughout his career. Those purchases, plus IBM’s two-for-one stock splits declared in January 1997 and January 1999 (per IBM’s filings), left the plan holding 8,000 shares with a cost basis of $231,000.

At IBM’s price of $244.89 as of 2:37 PM ET on Nov. 6, 2026, the shares are worth $1,959,120. That leaves $1,728,120 of net unrealized appreciation, or 88.2% of the position. The value moves with IBM’s stock price.

Two Paths, Two Very Different Tax Bills

The default: an inherited IRA. Most heirs roll the balance into an inherited IRA. The son is more than 10 years younger than his father, so he falls outside the eligible designated beneficiary category for someone “not more than 10 years younger” than the owner. That means he must empty the account by the end of the tenth year after the year his father died, per the IRS. Every dollar he withdraws, growth included, counts as ordinary income.

The overlooked option: a lump-sum distribution. The IRS treats a payout made “Because of the plan participant’s death” as a lump-sum distribution if the entire balance comes out within a single tax year. The son takes the IBM shares in kind, moving them as stock into a taxable brokerage account. IRS Publication 575 explains the result: “employer stock basis is taxed as ordinary income and appreciation is taxed later at capital gains rates.” The NUA “is generally tax free until you sell or exchange the securities.”

In this example, he reports $231,000 as ordinary income in the year of the distribution. The $1,728,120 of appreciation goes untaxed until he sells. At that point, The CPA Journal notes, it counts as a long-term capital gain.

Where the Rule Lives in the Tax Code

NUA treatment comes from 26 U.S.C. § 402(e)(4), which covers employer securities paid out of qualified plans. IRS Publication 575 lays out how it works. The CPA Journal points out how easy it is to miss: “NUA can frequently be overlooked when taxpayers look to consolidate older plans into one IRA or even at death when an heir is named the designated beneficiary of the plan.”

Who Qualifies and Who Already Lost the Option

The rule fits heirs who inherit employer stock still held inside a qualified plan such as a 401(k). The plan must allow in-kind distributions, and plan rules vary. If the stock already went into an IRA, the window has closed. In the CPA Journal’s words, “once the qualified plan is moved to an IRA, the opportunity for NUA is lost.”

How to Claim NUA Treatment Step by Step

1. Hold off on rollover paperwork until you’ve compared both paths.
2. Ask the plan administrator for the cost basis of the employer shares, and confirm the plan permits in-kind distributions.
3. Request a distribution of the entire balance within one tax year, with the employer stock moved in kind to a taxable brokerage account.
4. Check your Form 1099-R. The tax-deferred NUA should appear in box 6.
5. Plan for the tax on the basis. For 2026, single filers hit the 32% bracket above $201,775 of taxable income and the 37% bracket above $640,600.

Traps That Can Erase the Savings

• One tax year: The whole balance has to come out within a single year, so the $231,000 basis lands on top of his salary as ordinary income.
• No step-up: Stock inherited in a regular brokerage account usually gets its basis reset to market value at death. Stock inside the 401(k) misses out. Per The CPA Journal, “there is no step-up in basis for the NUA portion,” because it counts as income in respect of a decedent, which 26 U.S.C. § 1014(c) excludes from the step-up.
• Short-term gains: Any rise in value after the distribution is taxed as a short-term gain unless he holds the shares more than a year and a day, per The CPA Journal.
• No do-overs: Once the money moves to an IRA, the choice is final.

The NUA path is often cheaper. His tax brackets, state income tax and other income decide by how much. It’s one of a handful of quiet IRS rules that can quietly drain a six-figure retirement account, and we mapped nine of them in a free tax trap guide here.

Call a Pro Before Any Money Moves

Bring in a CPA or tax professional along with the plan administrator before choosing. In this example, more than $1.7 million of growth will be taxed either at ordinary income rates or at capital gains rates, and the paperwork you sign first locks in which one applies.

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