US treasury Accrued Market Discount

[p4lee]

I purchased US Treasury Notes/Bonds in the Secondary Market.  There were sold with an accrued market discount because current interest rates are above par.  In my 1099B, the accrued market discount was classified as short and long term gains.  

After automatically downloading the 1099B from my brokerage, it adjusted this short/long term capital gain and entered the gain as an Interest income on my Schedule B.  Is this correct?

Shouldn't a long term Accrued Market Discount be taxed as a long term capital gain instead on interest income, as listed on 1099B?

[Mike9241]

if properly reported accrued market discount adds to your tax basis in the Treasury security. thus the increase is reported as interest income. 

[p4lee]

OK thanks.  So even if it’s a long term capital gain, the accrued market discount is taxed as interest income?  And it is NOT exempt from state/local taxes?

[ron6612]

I purchase a .25% treasury serial note from fidelity website and held it to maturity. Fidelity has treated it as accrued market discount and a short term capital gain on the download rather than as interest income which would be exempt from state income taxes. Would it be okay to change the Fidelity download to turbo tax from capital gain to interest income?

[ron6612]

Does anyone have answer on this?

[SusanY1]

TurboTax has an entry field for accrued market interest, which will be treated as interest income.  It is okay to move the number to this field if it did not download and map properly. 

Accrued market discount is not exempt from state taxes, and TurboTax will treat it properly when in Box 10 on the 1099-INT screen.  Be sure to check "My form has info in other boxes" to see the input area for Box 10.

[ron6612]

So, should the income result in capital gain or interest income?  If interest income why not exempt from state taxes as it then wold be treasury income?

[DianeW777]

Accrued market discount from a US Treasury obligation is not deductible on the state return because the effective paid interest there was coming from a private party on the secondary market, not the US treasury.   If you buy the bond from the government, you can subtract the interest.   If you buy the bond from a 3rd party, the interest is not deductible. 

@ron6612 

[tmhaas]

Hi - Are you saying the interest is not deductible at the state level if you bought in the secondary market? Or, the Accrued Market Discount is not deductible if you bought in the secondary market? I've never read or heard the interest would not be deductible. 

[SusanY1]

Accrued Market interest isn't excludable at the state level.  This is because the interest isn't paid directly by the issue agency to the taxpayer. 

In order for interest paid to qualify for exclusion of tax by a state, it must generally be interest of a direct government obligation.  Accrued market discount doesn't meet this definition as it isn't the direct (or "coupon") interest.  

Unfortunately, there isn't a single consolidated link or citation that we can provide here as each state has different mechanisms for showing this ranging from court cases, codification into law, or state agency declarations.