ACCRUED MARKET

[yanks772]

I bought 12 secondary market bonds that materialized in 2023.  It seems that for all of them I made some money off of accrued market discount (ex. buying for 29,700 and getting back 30,000 so $300 gain for example) and other money from interest (for example $100).  I bought both Federal Treasuries and Municipal Bonds (NO corporate bonds).  It seems that my 1099-B form only lists 5 of the bonds (1 municipal bond and then 4 Treasury Notes) and not the other 7.  None of my Treasury BONDS are listed on the 1099-B, only my Treasury NOTES.  As I look through it seems that all 5 of the bonds on the 1099-B had some form of Accrued Interested (ex. the bond was between interest payments so there was $25 in accrued interest up to that point which I paid to the Bond seller and then got back when the bond materialized --- using the ex above I actually paid 29,725 and in the end at maturity got 30,000 bond + the 25 accrued interest + 100 interest due = 31,250 Total).  It seems that my other 7 bonds were reported in my 1099-INT and NOT on the 1099-R and that those bonds were very similar except for the fact there did not seem to be Accrued Interest paid for them.  I have 3 questions:

1. So I assume the 1099-R only reports bonds with accrued interest?  Since all my Treasury NOTES are on the 1099-R and none of my Treasury BONDS are, then I assume there is some difference between the two such that the way interest is paid for Treasury BONDS is done so in a manner such that Interest does not accrue or the accrued interest does not get included in the secondary market bond payment?

2. Based on the way things were input into Turbotax, the money made off of accrued market discount (ex. buying for 29,700 and getting back 30,000 so $300 gain) which is shown on the 1099-R for 5 of my bonds showed up on the tax forms as taxable income.  Since Treasury Notes are not taxed at the state/local level I assumed that the interest ALONG WITH THE GAINS FROM THE ACCRUED MARKET DISCOUNT would be state/local tax exempt.  Am I incorrect about this?  Is it only the gains on interest that are state/local tax exempt here in New York?  Also as mentioned above there were 5 of the bonds that showed up on the 1099-B and 1 was municipal so should everything associated with this secondary market municipal bond purchase be fully tax exempt or should the gain from the accrued market discount of this bond still be taxed (because it shows up on the 1099-R form and on TurboTax seems to be input as taxable profit which I did not think was the case as I thought the accrued market discount gains from municipals was still tax exempt?).

3. All of these bonds were bought for a quick turn-around and owned by myself for less than 1 year.  If I were to buy secondary market bond that did not materialize for >1 year would I be able to treat all of my gains as Capital Gains taxes?  I am in 35% Federal Income tax bracket so being able to only have to pay 20% Capital Gains taxes would make a big difference.

[baldietax]

Lots to unpack I'll give you my few cents... btw you are referring to 1099-R but I assume you mean 1099-B.

1. By Treasury BONDS I assume you mean T-Bills.  T-Bills are specifically issued for 12 month maturity or less and at a discount, they have zero coupon and no accrued interest.  These type of instruments have specific treatment in the tax code (IRS pub 550 deals with a lot of this) and the realization of the discount flows thru to 1099-INT, not 1099-B.

2. Yes the "gain" from the discount is reflected on 1099-B in col 1f Accrued Market Discount (AMD) which flows thru to interest income in the Fed part of TT.  The state/local exemption of this component is a hot topic in the threads and actually varies by state.  I've seen a couple of posts that it is not exempt in CA.  NC settled in the courts that it is not exempt.  For VA the tax code refers to "Income derived from obligations, or on the sale or exchange of obligations, of the United States" as exempt.  I don't know the answer for NY but you should check the state tax code to see the language/ruling/guidance on this or consult with a CPA etc if there is any doubt.  Some folks are being surprised by this issue this year I think as Notes purchased at discount in the past couple of years of big interest rate moves come due.  I think for this reason, TT does not do anything to flow this AMD to the state taxes or Intuit would have to take a position on this topic across all the state tax codes.

You mentioned a muni bond in the mix as well.  Unfortunately I think the market discount on munis can be subject to Fed taxes, both at maturity and if you sell the bond prior to maturity.  A muni may also have Original Issue Discount (OID) component in the mix which is Fed exempt, your broker should be doing all that math and sending you a 1099-OID for that.  If the discount is very small this is Fed exempt thru something called the "de-minimis rule" (0.25% per year from purchase to maturity i.e. if you buy a muni maturing in 4 years at a price of 99 that 1% of discount should be Fed tax exempt.  If you buy the same bond at a price of 98 that 2% of discount will be taxed as ordinary income) - however I am not entirely clear if that only applies to OID not the market discount.  Anyway - this is why lower coupon munis trading at discounts due to all the interest rate moves, generally price at higher yields than higher coupon munis, to account for the fact the coupon is Fed exempt but the discount is not.

So unfortunately depending on the details of your muni that AMD may be correct as taxable in TT.  There is a section in pub 550 on "Market Discount Bonds" which includes munis unless they were purchased before 1993...

3. It's a great question.  I had listened to a Guggenheim podcast last year pushing low coupon munis as a great idea because they could be sold for a capital gain if the price recovers before maturity.  But I have yet to find any documentation that is the case, and folks I have talked to at Fidelity were quite certain it was not the case and this was taxable as ordinary income and something to avoid.  Pub 550 "Market Discount Bonds" states "You must treat any gain when you dispose of the bond as ordinary interest income, up to the amount of the accrued market discount".  I think this applies for T-Notes also, I have not seen this personally but I assume if you sell a T-Note it will show up on 1099-B as AMD the same way as holding to maturity and flow to interest income.

Hope this helps - Pub 550 is worth a read to see how these products are treated.