What happens to TIPS in deflation?

- R
- Rich Carreiro
  
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posted
15 years ago

Fri, Jan 30, 2009 6:36 PM

As you may know, the way TIPS work is that the principal amount of the bond is indexed to CPI-U. Each year the inflation adjustment of the principal (which to date has always been positive) is reported on 1099-OID and is fully taxable even though no cash is received for the adjustment (much like how interest accruals on a zero coupon bond work).

So, what happens if we have a drop in CPI-U and the principal value of the bond is adjusted downward? Is it treated as negative OID? Capital loss? Basis adjustment? Investment expense? Something else?

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

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- M
- MyVeryOwnSelf
  
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posted
15 years ago

Wed, Feb 4, 2009 2:16 AM

If [OID comes out as] a negative number, you do not have any OID. Instead, you have a deflation adjustment. A deflation adjustment generally is used to offset interest income from the debt instrument for the tax year. Show this offset as an adjustment on your Form 1040, Schedule B, in the same way you would show an OID adjustment. ... You decrease your basis ... by the deflation adjustment used to offset interest income.

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