For discounted bonds purchased after 1982 and held to maturity the IRS claims the discount is interest. When such bonds are held more than a year the bond discount can be amortized by the number remaining days to maturity and increasing its basis accordingly for each year the bond is held. The amount by which the basis in increased is reported as ordinary income (interest) for that year . Alternatively you can wait until the year of maturity and adjust the basis by the full amount of the discount. Look at your 1099 B and you will see gain/loss set to zero.
You adjust the basis by entering a D in column f of form 8949 and entering the amount of the basis in column g by the discount (a negative number) this will result in a net zero cap gain (0). The amount in column g is recorded as ordinary income (interest) and reported on 1040 schedule B Part I.
The IRS now treats cap gain on any bond held to maturity as interest (treasury or corporate) If the IRS recognizes this as interest on a US Treasury obligation that means no state can legitimately claim its taxable at the state level. I would dearly love to reduce my federal taxes by claiming these are long term gains or even short term gains (offset by capital loss carryovers) The IRS says no - its interest.
You need to remove all such bond interest that TT transfers to your state return. I did it by overriding the entries on my state tax return interest worksheet and it all passed TT review. Doing it any other way failed review.
