He Inherited Nearly $2 Million in IBM Stock at 52. The Little-Known IRS Rule That Can Turn Most of It Into Capital Gains Instead of Ordinary Income

What looks like a retirement windfall can become a tax headache when company stock is involved. For heirs, a single rollover decision can determine whether nearly $2 million is taxed at top ordinary income rates or mostly as capital gains.

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When a parent leaves behind a 401(k) loaded with employer stock, the default paperwork can be costly. A little-known IRS provision known as net unrealized appreciation (NUA) allows an heir to move company shares out of an inherited 401(k) and pay capital gains tax on much of the growth instead of ordinary income tax. Many beneficiaries do not discover the option until after the assets have already been transferred.

A Hypothetical $2 Million 401(k) Inheritance

This example is hypothetical and is meant to illustrate how the rule works. A 52-year-old son is the named beneficiary of his father’s 401(k). The father worked for 33 years as a systems engineer at IBM (NYSE:IBM | IBM Price Prediction) and accumulated IBM stock in the plan over the course of his career. Those purchases, along with IBM’s two-for-one stock splits announced in January 1997 and January 1999, left the account holding 8,000 shares with a cost basis of $231,000.

Using IBM’s share price of $244.89 at 2:37 PM ET on Nov. 6, 2026, the stock would be worth $1,959,120. That creates $1,728,120 in net unrealized appreciation, or 88.2% of the position. The exact value would change with IBM’s stock price.

Two Choices, Very Different Tax Consequences

Default route: an inherited IRA. Many heirs roll the balance into an inherited IRA. In this case, the son is more than 10 years younger than his father, so he does not qualify as an eligible designated beneficiary who is within 10 years of the owner’s age. As a result, he would have to empty the account by the end of the tenth year after the year of death, according to the IRS. Every withdrawal, including growth, would be taxed as ordinary income.

The less obvious route: a lump-sum distribution. The IRS treats a payout made “because of the plan participant’s death” as a lump-sum distribution if the full balance is paid out in a single tax year. In this example, the son takes the IBM shares in kind and transfers them into a taxable brokerage account as stock. IRS Publication 575 says the employer stock basis is taxed as ordinary income, while the appreciation is taxed later at capital gains rates. The NUA is generally tax free until the shares are sold or exchanged.

Under that approach, the son reports $231,000 as ordinary income in the year of distribution. The remaining $1,728,120 in appreciation is not taxed until he sells the shares. At that point, The CPA Journal says it is treated as a long-term capital gain.

Where the Rule Comes From

The NUA rule is found in 26 U.S.C. § 402(e)(4), which covers employer securities distributed from qualified plans. IRS Publication 575 explains the mechanics. The CPA Journal says the benefit is often missed: “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 Can Use It, and Who Cannot

The strategy applies to heirs who inherit employer stock that is still inside a qualified plan such as a 401(k). The plan must permit in-kind distributions, and plan terms can differ. If the shares have already been rolled into an IRA, the opportunity is gone. As The CPA Journal puts it, “once the qualified plan is moved to an IRA, the opportunity for NUA is lost.”

How to Seek NUA Treatment

1. Pause before signing rollover forms and compare the available options.
2. Ask the plan administrator for the employer stock’s cost basis and confirm that in-kind distributions are allowed.
3. Request a full distribution within one tax year, with the employer shares transferred in kind to a taxable brokerage account.
4. Review Form 1099-R. The tax-deferred NUA should appear in box 6.
5. Prepare for the tax on the basis amount. For 2026, single filers reach the 32% bracket above $201,775 of taxable income and the 37% bracket above $640,600.

Common Mistakes That Can Eliminate the Benefit

• Single tax year: The entire balance must be distributed in one year, so the $231,000 basis is added to his salary as ordinary income.
• No step-up in basis: Stock inherited in a regular brokerage account usually receives a stepped-up basis at death. Shares inside a 401(k) do not. The CPA Journal notes that “there is no step-up in basis for the NUA portion,” because it is treated as income in respect of a decedent, which 26 U.S.C. § 1014(c) excludes from the step-up.
• Short-term gains: Any increase in value after distribution is taxed as a short-term gain unless the shares are held for more than a year and a day, according to The CPA Journal.
• No second chance: Once the money is rolled into an IRA, the election is final.

In many cases, the NUA route produces a lower tax bill. The exact savings depend on the heir’s tax brackets, state income tax, and other income. It is one of several lesser-known IRS rules that can quietly erode a large retirement account.

Get Expert Advice Before Moving the Money

Before making a decision, a CPA or tax professional should be consulted along with the plan administrator. 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 first paperwork signed will determine which treatment applies.