Accrued Market Discount for tax-exempted bonds

[Phen]

Are accrued market discounts for tax exempted bonds taxable on federal returns?

I researched this topic online and found discussions that are in conflict with each other. Could someone please 

clarify this issue as well as providing a reference/source where I can find legal support (e.g. specific IRS guidelines regarding it, etc.) for backing the answer? (Would like to be able to defend myself, if filing my return based on the advice and being audited by IRS later.)  Thanks.

[baldietax · Accepted solution]

yes, see Publication 550 "market discount bonds" on p21 which includes tax-exempt bonds (unless purchased prior to 5/1/93), if the price is below the deminimus amount (0.25% per year).  that's why low coupon, discounted munis generally trade for higher yields as part of that yield is taxable.  most brokers do all this bond math and report the AMD and G/L accordingly.

"Market discount is the amount of the stated redemption price of a bond at maturity that is more than your basis in the bond immediately after you acquire it. You treat market discount as zero if it is less than one-fourth of 1% (0.0025) of the stated redemption price of the bond multiplied by the number of full years to maturity (after you acquire the bond)"

https://www.irs.gov/pub/irs-pdf/p550.pdf

[Phen · Accepted solution]

Thank you!