# Tax Treatment of Secondary Market CD's

Say I am considering two different 2-year CD's both with the same yield to maturity but one is sold under par (since its interest rate is below market rates), the other above par (since its rate is above
market). For concreteness, let me make up some numbers that are not accurate but allow me to be specific: Say the current market rate for 2-year CD's is 3%. The first CD has a face value of \$1000, it pays a rate of 2% (\$20 interest per year) and sells for \$900; the second one has a face value of \$1000, it pays a rate of 4% (\$40 interest per year) and it sells for \$1100.
1. I am assuming that during the time that I hold the CD's, I pay regular tax rates on the income received. When the first CD matures after 2 years, I have a capital gain on the difference \$1000 - \$900 \$100. When the second CD matures after 2 years, I have a capital loss of \$1100 - \$1000 = \$100. Is this correct?
2. Does it matter if the CD is held to maturity, or would the same considerations apply if it were sold before maturity, in which case the sales price of the CD's would not necessarily be \$1000?
3. Given, in this example, that the yield to maturities are the same, would it be beneficial to purchase the second CD and not the first since you have to pay capital gains tax on the first one but get to claim a loss on the second one, or, in practice, would the yields to maturity be reflective of the capital gains tax/loss that you have at the end?
Thanks.
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CD's sound like bonds, so publication 550 at http://www.irs.gov/publications/p550/index.html is the definitive guide. Fun reading!

Not quite. You have to figure out the true price of the bond in order to figure out your market discount, if any. For example, if you bought the \$900 bond one day before maturity and received \$20 interest plus \$1000 the following day, the market discount is pretty much all of the \$100. The market discount is treated as ordinary interest income, usually in the year the bonds mature, although you can elect to pay a little every year.
To figure out the true price of the bond you need to know the price of the bond when it was originally issued and the number of years to maturity.
If the true price of the bond one day before maturity was \$999, and you paid \$900 for it, your market discount is \$99. With the ordinary interest of \$20 you have \$119 of interest income. And you have a capital gain of \$1.
And be aware that if you made an election to amortize your taxable bonds, then you have to increase or reduce your ordinary interest income by the amortization, but you have no capital gain when the bond matures or is called.

The same method as above applies. But you have to calculate the true price of the bond when you sell it, which might be less than \$1000. And you have to worry about accrued interest issues as well.
You even have to worry about accrued interest when you buy the bond on the secondary market.

Have to do the full calculations to be sure.
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