Capital Gains or Losses for Bonds

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Capital gains/losses on bonds work in essentially the same manner as stocks and other securities. Tax lots apply as does first in, first out sales rules, unless a special purchase is identified. There are a few differences to be aware of and this lesson touches on those.

US Treasury Bills

US Treasury Bills are sold at a discount and do not pay interest (coupon) during their life. The difference between the price paid and the face value of the bond is interest. There is no gain or loss at maturity. Rather the difference is interest income and is reported as such on your tax return. It is also reported in this manner on your 1099 information reporting at year-end. A tax compliance tip: Even though an item has no gain or loss, the sale, or in this case redemption, must be reported on your tax return. Brokers’ information reporting will include zero gain/loss items and even though they have no impact on tax liability, they must be reported as the IRS looks to match the broker submitted reporting to your tax return submission. Failure to report these items will generate IRS – CP2000 notices requesting additional information and possibly tax from you.

Corporate Bonds

The treatment of corporate bonds for calculating gain or loss is exactly the same as the treatment for stocks. Keep in mind that the maturity of a bond is a disposal of the holding and must be reported.

Municipal Bonds

We think of muni bonds as always being federally tax-free and, and if they are from your resident state, state tax-free. Not quite. Capital gains and losses on these bonds are subject to both federal and state tax when sold or held to maturity. Interest income is exempt from federal taxes, and state taxes if you are a resident of the state the muni was issued by.

Bond Premiums and Discounts

Bond premiums and discounts are added to and subtracted from the cost basis of a bond over the life of a bond. Bonds purchased after January 1, 2013 are covered securities and therefore your broker will provide the necessary information to you. Bonds purchased before this date require more record-keeping on the part of the taxpayer. The cost plus or minus any market discount or premium amortized over the holding period of the bond is the simplest calculation of the basis.