February 1, 2010
When a bond is acquired at a discount to the face value, there are different kinds of discounts and differing tax treatments. The tax reporting is often misunderstood, which could cost you money in additional taxes and/or penalties.
The gain at maturity or sale of a market discount bond is ordinary income (i.e., interest) and not capital gains. This applies to all bonds, including tax-exempt bonds.
Instead of recognizing the entire discount as ordinary income in the year of disposition, you can elect to accrue the market discount in interest income ratably each year. This would keep you from recognizing the entire amount in one year and potentially paying tax at a higher rate.
There are many rules regarding market discount bonds and the tax reporting can be quite complicated. My recommendation is to consult a tax advisor before proceeding down this road alone.
Next week I will discuss the tax reporting of bonds purchased at a premium.
Until then...happy tax season!
(This article contains the current opinions of the author but not necessarily those of Brighton Securities Corp. The author's opinions are subject to change without notice. This blog post is for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities).