Presumably, if done properly, your financial services statement on account showing the zero coupon bond will present a cost basis not of your original cost but added to that each of the imputed but not received interest amounts that accumulate over the life of the bond.
The following assumes that you purchased the zero coupon bond at issue time and not in the secondary market, as you did not indicate, nor did you indicate if the cost basis was adjusted after each imputed interest accumulation.
The tax rules for zero-coupon bonds bought as new issues and held to maturity are fairly simple.
Whether the bond is taxable or tax exempt, you (or your broker) have to accrue interest on the bond. That means you have to calculate the portion of the difference between the purchase price and face value that accrued to you each tax year, even though you didn't receive any payment. The interest accrues at the interest rate you obtained when you bought the bond. Using the earlier example, if you paid $500 for a 10-year, $1,000 bond getting an interest rate of 7.05%, you would accrue $35.25 of interest in the first year.
$500 x 0.0705 = $35.25
Your adjusted issue price, or cost basis, in the bond, would then become $535.25.
$500 + $35.25 = $535.25
The following year, you would accrue $37.74 of interest.
$535.25 x 0.0705 = $37.74
And so on.
If this posted response is useful to you, please click on the upraised hand in the lower left of this post. Thank you. Scruffy Curmudgeon--PFFM/ IAFF, retired FireFighter/Paramedic - Locals 718/30, Veteran USAR O3 AIS/ASA '65-'67
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