Maturing market discount bond

amaturingbond that had been bought at less than face value.

I normally add the amortization to the cost basis, so the cost basis and proceeds are both 10k, no additional line.

Not quite. The schedule B for 2007 would have about 4 months and 20 days (about 4.66 months) of the discount, while the schedule B for

2008 would have 9 months of the $1000 discount. So roughly about 4.66/13.66 or 34% of the $1000, or $341 would be in 2007, and the remainder in 2008. But you probably have to use the constant yield method to get the exact numbers.

Sounds reasonable to me. You can have a spreadsheet with all the details on one line, but just combine them into one for Schedule B to save typing so much stuff, and if the IRS asks send them the spreadsheet.

Just be sure that your broker does not already include amortization on their Schedule B. They probably don't, but just in case...

Yes.

I disagree that this is not correct. Although the taxpayer can elect to report the market discount each year, absent such an election (which might have onerous side-effects, so you generally don't want to do so), the taxpayer reports the entire market discount for all years the bond was held in the year of sale or maturity. So in the OP's case, this is $1000, reported entirely in 2008.

I base this on the discussion on Page 15 of Pub 550.

I'm interested in hearing other opinions though.

Steve

Thanks for the info.

But I also ran into a variation of the example. Suppose the bond was called for 10,100 before maturity, but after the bond was held for a year. Does this result in:

- 1,100 market discount?

- 1,000 market discount and 100 long-term capital gain?

- something else?

I haven't noticed this case spelled out in Pub 550.

| But I also ran into a variation of the example. Suppose the bond was called | for 10,100 before maturity, but after the bond was held for a year. Does | this result in: | | - 1,100 market discount? | | - 1,000 market discount and 100 long-term capital gain? | | - something else?

Well, if you believe this:

the answer might be "something else" as the market discount is applied over the life of the bond. I found this particular article more clear than most. It gives examples that answer the kinds of questions I ask rather than avoiding those cases as many publications do. (Note that it covers the case where the bond is sold without recovering the discount.) That probably means that it is wrong or at least over-simplified. :( Also, while the title of the article includes "Municipal" it appears to make the distinction between taxable and tax-exempt bonds as necessary.

Of course, with the perpetual tweaking of bond tax rules the article might also be out of date. As with premium amortization on munis they may have found new ways to accelerate recognition of market discount. I keep waiting for someone to come up with the holy grail to make the actual interest payments of municipals partially directly taxable. I'm sure someone thought of the obvious argument that a muni purchased below par has exempt interest only up to (coupon) * (purchase price) with the rest being taxable, but then realized that this would just have a weird effect on market prices. :)

Dan Lanciani ddl@danlan.*com

The above link, fifth question down, says otherwise. It says to take it all in year of sale/disposition.

Steve

In article , snipped-for-privacy@speedymail.org (Steve Pope) writes: | Dan Lanciani wrote: | | > snipped-for-privacy@emailNot.invalid (MyVeryOwnSelf) writes: | | >| But I also ran into a variation of the example. Suppose the bond was called | >| for 10,100 before maturity, but after the bond was held for a year. Does | >| this result in: | >| | >| - 1,100 market discount? | >| | >| - 1,000 market discount and 100 long-term capital gain? | >| | >| - something else? | | >Well, if you believe this: | >

| >http://www. ``For bonds acquired after April 1993, the amount of a bond's market discount is accreted between the bond's date of acquisition and its date of maturity. Accreted market discount must be included as ordinary, taxable income in the year a bond is sold, redeemed or otherwise disposed of.''

It seems clear that they are saying that you do not take all the market discount in the year of sale/disposition unless that disposition is at maturity. Why talk about an accreted value if that value is always the whole amount?

If this is correct (and unless there is some other rule that accelerates the accretion of market discount on call) you might not recognize the full market discount on call; some of it could still be capital gain. They give several examples that appear to make this quite clear. I'm not claiming that they are correct, but if they are (and again if there is not some gimmick that accelerates recognition of market discount on call rather than sale) then the example above would result in something less than $1000 in ordinary income and something more than $100 in capital gain.

Consider something more dramatic:

Yesterday I bought a bond at 90, i.e., at a market discount of 10. Today I sell it for 100, i.e., at par. Would I recognize all of the 10 point market discount as ordinary income?

Dan Lanciani ddl@danlan.*com

Thanks. What might the onerous side effects be? One would imagine that reporting $10,000 interest every year for 10 years is better than reporting $100,000 in one year, as the latter can push you into a higher bracket. Of course, that only applies to taxable bonds (such as corporate bonds or munis from another state).

I guess I disagree with your interpretation of this sentence. This sentence says you accrete the discount as you hold the bond, and then you report the entire accreted amount in the year of sale, redemption, or maturity.

As for "why talk about an accreted value", I suspect it is to make clear you can't ultimately report this amount as a capital gain, which is what you might like to do.

Tangentially, the IRS publications do not use the term "accrete" for this situation (that I recall).

Steve

In article , snipped-for-privacy@speedymail.org (Steve Pope) writes: | Dan Lanciani wrote: | | > snipped-for-privacy@speedymail.org (Steve Pope) writes: | | >| The above link, fifth question down, says otherwise. It says | >| to take it all in year of sale/disposition. | | >It says: | | >``For bonds acquired after April 1993, the amount of a bond's market discount | >is accreted between the bond's date of acquisition and its date of maturity. | >Accreted market discount must be included as ordinary, taxable income in the | >year a bond is sold, redeemed or otherwise disposed of.'' | | >It seems clear that they are saying that you do not take all the market | >discount in the year of sale/disposition unless that disposition is at | >maturity. Why talk about an accreted value if that value is always | >the whole amount? | | I guess I disagree with your interpretation of this sentence.

They give several examples that make it clear that in some cases the amount taxed as ordinary income is less than the entire market discount. Again, I'm not saying that they are correct, but they at least explain their position consistently.

| This sentence says you accrete the discount as you hold the bond, | and then you report the entire accreted amount in the year of sale, | redemption, or maturity.

I agree. The question is whether the "entire accreted amount" is equal to the total market discount at time of purchase in cases other than holding to maturity. I wonder if we are merely using different wording. It would be helpful if you could respond to either the example I responded to (buy 9000, call 10100) or the more extreme example I suggested (buy 90, sell 100 the next day) with actual numbers so I could understand how (if at all) you disagree with the article.

| As for "why talk about an accreted value", I suspect it is to make | clear you can't ultimately report this amount as a capital gain, | which is what you might like to do.

It seems to be more than that:

``An investor may choose to accrete market discount on a daily basis using the ratable, or straight-line method, or using the constant interest rate method.''

Two possible methods to compute a value which is always the total seems odd...

Might as well copy their whole example in case others don't want to go to the web site:

``For example, suppose an investor buys a tax-exempt bond--originally issued at par--in the secondary market at a price of 90 with ten years left until maturity. Five years later, he or she sells the bond at a price of 95. Assuming the discount is amortized on a straight-line basis, the investor must treat the five-point gain as ordinary income in the year the bond is sold. (Total market discount at the time the bond is purchased is ten points, accreted on a straight-line basis over the ten years until maturity. After five years, accreted market discount totals five points.) Suppose under the same circumstances, the investor sells the bond after five years at a price of 96. Five points (the total accreted market discount) are taxed as ordinary income and one point is taxed as a capital gain. Suppose, again under the same circumstances, that the investor holds the bond to maturity. Ten points (the entire amount of market discount) are taxed as ordinary income in the year the bond is redeemed. Finally, suppose the investor sells the bond after five years at a price of 88. In this case, the investor would recognize no market discount income and would recognize a capital loss of two points.''

| Tangentially, the IRS publications do not use the term | "accrete" for this situation (that I recall).

Accrete, accrue, and amortize seem to have lost whatever subtle distinction they once had...

Dan Lanciani ddl@danlan.*com

Thanks to all who replied.

This was the last uncertainty for me. Now I don't see anything in pub 550's discussion of market discount that indicates acceleration if the bond is called.

So I'll go with the investinginbonds.com summary of pub 550's provisions, pro-rating the market discount over the holding period.

Making said election constrains one to using such accounting for all bonds in the future, unless the IRS gives you permission to change your mind. This could be onerous.

Sure, but in other circumstances you might prefer not to pay the tax until the bonds are disposed of. Particularly since you could end up paying tax on interest that you never see because the bonds get wiped out at some future point. You might be forced to pay this ongoing tax even on speculative bonds.

Steve

Right.

Your gain has to equal or exceed the entire accreted amount for you to pay tax on the entire amount. Otherwise, you only pay tax on the amount of the gain.

"You must treat any gain when you dispose of the bond as ordinary income, up to the amount of the accrued market discount".

The rest of the gain, if any, is capital gain. If the gain is less than the accrued market discount, you report only the gain as interest income.

Steve

Has anybody figured out how to get TurboTax to report this correctly?

According to IRS publication 550 for 2008 (page 50, column 2, paragraph 3), extra lines are needed on Schedule D and schedule B. One problem is that the extra Schedule D line needs have the "profit/loss" column filled in but the "proceeds" and "cost" columns both empty. TurboTax doesn't seem to allow this, except by overriding, with who-knows-what side-effects. (It's sort of like a "Wash Sale" line; TT software knows about wash sales, but apparently not about accrued market discount for bonds.) This question was posted on the TT forum web site, but there has been no response.

Personally, I do not see why these particular P550 instructions are there. More logical is to enter only a single line for the transaction, with the accrued market discount included in the cost/basis.

Any ideas on if this is okay, and if not what is the purpose of the reporting per 550 with an extra line?

Steve

Short term capital gain (except for one day's worth of accretion).

Seth