What is Net Unrealized Appreciation?

Net unrealized appreciation refers to the amount of money a stock in a tax deferred account has gone up, before that stock has sold. The appreciation refers to the fact that the stock has risen in value. The appreciation is unrealized because the stock hasn't been sold yet, so the gains or increase in value has not yet been taken by the investor. It is also considered to be net unrealized appreciation because it is in a tax deferred account, so no deductions of taxes have to be made for it.

Assume, for example, that an individual purchases 100 shares of stock at $1 US Dollar (USD). That person spent $100 USD to buy the stock. He likely also paid a commission, so the purchase probably cost around $107 to $110 USD, depending on the amount of commission paid. If the stock price rises to $2 USD per share, the investor now has $200 USD. His appreciation — or the rise in value of his asset — was $90 to $93 USD depending on the amount of commission he paid.

As the stock's appreciation is only on paper until the individual sells the stock, that appreciation is unrealized. If that stock was purchased in a 401(k) account, the growth of the stock is also not taxed, since the stock is a tax deferred account under Internal Revenue Service (IRS) rules. As such, this is the net amount of appreciation the individual has experienced.

Understanding the concept of net unrealized appreciation is important for investors who need to make changes to their 401(k) plans. If, for example, a person leaves his employer who offered the 401(k), that individual may face a choice as far as what to do with the funds in the 401(k). If there has been net unrealized appreciation in the funds, it is a wise idea to roll those funds into another form of tax deferred investment account, such as an Individual Retirement Account (IRA).

Rolling the funds into an IRA allows the individual not only to avoid penalties associated with liquidating a 401(k), but it also allows the investment to remain tax-free. If the investor did not make such a decision and instead either rolled the money into an account which was not tax deferred, or cashed out his 401(k), he would have to pay substantial taxes on the net unrealized appreciation on the assets in his account.