Gain on Brokered CD Purchased at Discount- Is Gain Taxable at Maturity?

CDs generally generate interest income, not capital gain income.

You should check the interest income section of the 1099. The discount should have been reported as interest income there (perhaps split between two tax years), so that the basis of the CD at maturity would be its maturity value. No capital gain.

But these are *brokered* CD's (Smith Barney) and they were sold to me at a discount, so when they matured at face value there was a gain! (This of course in addition to the interest I received.)

The CD redemptions that I have seen on MSSB 1099s usually have two lines: the first line is the original (discounted) price, and the second line is the adjusted cost (usually face value).

BTW even if you were in the 15% bracket you still need to report capital transactions. They may be taxed at 0%, but they still need to be reported (it can affect other places on the tax return, such as medical or miscellaneous deductions.

That difference may be OID, which again is interest income, not capital gain.

Are you certain that the interest reported is less than the sum of the interest earned plus any discount you received in the purchase?

Is this not just what Original Issue Discount (OID) is all about? I ranted about this a week or two ago even though I am far from being an expert on the subject. It just is another way Congress has increased our paper work load over the years from purchase to maturity, just to get a little more tax earlier. I would like to hear from a true expert whether I am right or wrong.

Bill

The interest earned by a CD is interest.

If you have purchased a brokered CD you will receive a 1099B when selling/redeeming it, and report that sale on Schedule D.

Brokers usually maintain a secondary market in CDs.

These CDs are not redeemed but sold into the secondary market. Most likely these CDs were purchased at a discount on the secondary market.

Smith Barney has very good at reporting taxable gains and losses. The cost basis on their reports are adjusted as needed. Request a 2009 detailed gain or loss statement from your broker. You can also get it on smithbarney.com. Use the figure that they provide.

frank1492 wrote:

I think the point was that sometimes CD's or other debt instruments that earn periodic interest, are sold for more than face value. And it's that difference (assuming face value was the original purchase price), rather than interest per se, that was at issue.

Sorry, I had that exactly backwards. OP said he purchased at a discount and then sold at a higher price. That's separate from the interest. Though I gather that increase is treated as interest nonetheless.

Are you sure? Bonds of a year or less are typically sold at a discount and redeemed at par, with the difference being the interest. But longer term bonds are typically sold at par, pay interest twice a year, and are redeemed at par.* If you buy such a bond and the prevailing interest rate is different from the coupon rate of the bond, you'll pay more or less than par to compensate.

Is that gain or loss still considered interest? It seems more like a capital gain or loss.

R's, John

• - Yes, I know sometimes they set the coupon and then adjust the price, but I'm simplifying.

That's only true for bonds sold at original issue. Bonds sold in the secondary market will very rarely sell at par. They'll sell at a discount (possibly a considerable one) if interest rates have risen since issue and they'll sell at a premium (possibly a considerable one) if interest rates have dropped since issue.

That's true, absent default or various call-protection terms.

Rationally it's a capital gain or loss. However, tax law says that the discount is recognized year-by-year as interest (that's OID, even (confusingly) when the bond was not bought at original issue) and the premium is amortized year-be-year as a reduction of interest.

So if the bond is held to maturity its basis is exactly and by definition equal to its par value and there is neither capital gain nor loss upon maturity.

-- Rich Carreiro snipped-for-privacy@rlcarr.com

When you buy a bond, you buy it at a yield. If you buy it at a discount (coupon < yield), the yield is taxable income (the discount amortizes, and that amortization is considered interest). If you buy it at a premium (coupon > yield), the premium amortizes and that amount of the coupon is considered return of capital.

If you sell it before maturity, the difference between your cost +- amortization and the price you receive is capital gains.

If I buy a bond at par, its price drops, and I sell it to you for $90, I have a $10 capital loss, and over time you'll have $10 taxable interest income (in addition to the coupon). If I buy a bond at par, its price increases, and I sell it to you for $110, I have $10 capital gain, and over time your taxable interest income is $10 less than the coupon.

Once upon a time, the principal was considered the bond. This led to a tax shelter: buy a Treasury for par, strip off the coupons, and sell the principal for, say, $50. There was an immediate $50 capital loss; the coupons were interest income, but only as received, over the next few decades.

Seth