sale of defaulted muni bond

I had a muni bond which went into default about a year ago. Subsequently it sat in my account priced at about 1% of face value. I placed a market sale order and it did indeed sell, again for about

1% of face value. Do I need to do anything special because it was tax exempt and/or because it defaulted or can I compute the capital loss in the usual way, making the normal adjustments to basis? Did OID stop accruing when the bond went into default?

Dan Lanciani ddl@danlan.*com

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Dan Lanciani
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ddl@danlan.*com (Dan Lanciani) posted:

I was completely with you, and ready to tell you that you should proceed exactly as you suggested -- that is, "in the usual way" -- until you raised the OID question? Are you suggesting that this particular muni bond did not pay "tax-free interest" -- but rather, was a "zero-coupon bond"?

If you're not suggesting that, then my initial impulse stands. If you somehow bought a "zero-coupon" muni bond, then there's a whole new world of complexity. Have you been "accruing" imputed-interest? How?

I hope that OID statement was some kind of wild hair, because if so, you simply enter your original purchase date and then the sale date, show the proceeds, and then enter your original cost + any commissions to establish a total cost basis, and the difference should become a long-term capital loss, all in the "usual way."

Bill

Reply to
Bill

In article , an_ordinary_guy snipped-for-privacy@hotmail.com (Bill) writes: | | ddl@danlan.*com (Dan Lanciani) posted: | | >I had a muni bond which went into default | >about a year ago. Subsequently it sat in my | >account priced at about 1% of face value. I | >placed a market sale order and it did indeed | >sell, again for about 1% of face value. Do I | >need to do anything special because it was | >tax exempt and/or because it defaulted or can | >I compute the capital loss in the usual way, | >making the normal adjustments to basis? Did | >OID stop accruing when the bond went into | >default? | | I was completely with you, and ready to tell you that you should proceed | exactly as you suggested -- that is, "in the usual way" -- until you | raised the OID question? Are you suggesting that this particular muni | bond did not pay "tax-free interest" -- but rather, was a "zero-coupon | bond"?

No, it was not a zero-coupon bond but its issue price was (as is often the case) slightly under par. Typically OID on a muni is treated as tax-exempt interest. It accrues over the life of the bond, increasing its basis. It occurs to me that once the bond is in default it may well no longer satisfy the requirements of a tax-exempt instrument so perhaps I had *taxable* OID interest between the default and the sale. Of course, these are really small numbers we are talking about and they don't matter much. My main concern was that there might be some loss limitation gotcha on munis that I wasn't aware of.

Dan Lanciani ddl@danlan.*com

Reply to
Dan Lanciani

How slightly? IIRC, there's no OID income if it's slight enough, only when the bond is intentionally issued with a below-par coupon and accretion.

Why not? It was still issued by a municipality, right?

If it was in default, there's no income, OID, coupon or accrual.

Seth

Reply to
Seth

ddl@danlan.*com (Dan Lanciani) followed up to my original response [omitted for brevity] as follows:

I can only say that many munis are sold in the secondary market at discounts -- therefore, yielding slightly above the actual coupon amount. This does not change their status as "tax-exempt," and in the instance where a buyer would subsequently sell such bonds, it should have no effect on the "tax exempt" interest previously received, which should have been timely recorded in each previous year's 1040 on line

8b.

Your sale "at market" of the instrument established a legitimate long-term capital loss, and the appropriate entries should be made on Schedule D.

Bill

Reply to
Bill

This is a really big deal, isn't it? I mean, when WOOPS (sp?) failed some twenty-odd years ago it was splashed all over the financial press. (Washington Oregon Power . . ., it kind of spelled Whoops)

It you want to blow off some steam and share the details, I'd be very interested.

-Doug

Reply to
Doug

In article , snipped-for-privacy@panix.com (Seth) writes: | In article , Dan Lanciani wrote: | | >No, it was not a zero-coupon bond but its issue price was (as is often | >the case) slightly under par. | | How slightly?

Looks like it issued at around 96.4.

| IIRC, there's no OID income if it's slight enough, only | when the bond is intentionally issued with a below-par coupon and | accretion.

For taxable bonds minimal OID may (must?) be disregarded in the sense that it merely adds to the gain (reduces the loss) at redemption. This is of course good for the owner since it converts interest into capital gain taxed at a lower rate. For tax exempt bonds disregarding the OID would convert what was allegedly tax exempt interest into taxable capital gain. Last time I checked this was not required (though I'm sure the IRS wouldn't object to your paying extra taxes :). A change to that effect may well have occurred--it certainly wouldn't be out of character with the perpetual tweaks to muni accounting. (In the good old days you could recognize all the OID even if the bond was called prior to maturity. Now you have to accrue.)

This all raises the fascinating question of whether you could disregard OID on a muni that was originally tax exempt but became taxable through some violation of the rules.

| >It occurs to me that once the bond is in default it may well | >no longer satisfy the requirements of a tax-exempt instrument | | Why not? It was still issued by a municipality, right?

Sure, but isn't there a lot more to it that that? Every time I purchase a muni at issue I get a complicated prospectus with opinions as to the (non) taxability of the interest, and they always make a big deal about the importance of continues compliance with various rules. I can imagine that an entity in enough trouble that they are going to default on payment might forget to cross all the t's and dot all the i's.

Dan Lanciani ddl@danlan.*com

Reply to
Dan Lanciani

| This is a really big deal, isn't it?

Nah, I don't think so. It was a legitimate public health bond (hospital funding) and they just didn't make it.

| It you want to blow off some steam and share the details, I'd be very | interested.

If you want to see something really bad, Google Holmes Harbor sewer bond. It is unique it that it really looks like it may have all been a fraud from the start. I own 20 of those bonds as I watch the litigation drag on and on...

Dan Lanciani ddl@danlan.*com

Reply to
Dan Lanciani

Whoops bonds were revenue bonds, killed off in the debate over nuclear power plants. Very simply, the political climate went negative on nuclear plants and the license was never issued, and the bond holders were left holding the bag.

But around that time the Soverign State of New York succeeded in issuing a new type of muni bond: instead of being General Obligation bonds backed by the taxing authority represented by the full faith & crdit of the State of New York, or revenue bonds, or any other known species of bond, these bonds were backed by the "Moral Obligation" of the State of New York.

No need to keep you in suspense. The morality of the State of New York and its executive, judicial and legislative leaders turned up on the missing persons lists. At least here, bonds were redeemd at only a small discount, and only after much mud slinging and caterwailing.

Reply to
Arthur Kamlet

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