Interest shortfall on contingent payment debt

[benashton]

I had a Goldman Sachs certificate of deposit. Although the interest isn’t paid until the CD's maturity date, an estimate of the interest earned for the year is reported on Form 1099-OID and is taxed at the ordinary income rate.

When the CD matured in Nov. 2021, it was sold and the proceeds, cost basis, and gain/loss were reported on Form 1099-B as a redemption and ordinary gain/loss. But the 1099 also lists an amount labeled “interest shortfall on contingent payment debt.” The amount is also listed in the “Detail for Interest Income” section of the 1099.

The interest shortfall amount is equal to the total OID that I have paid taxes on since the CD was issued. I shouldn’t have to pay taxes on the entire gain from the sale since I’ve already paid taxes on the total OID. One way to handle this is to reduce the cost basis by the interest shortfall amount, which in this case will turn the gain into a loss. Is this correct? If not, how should it be handled?

The 1099-B has additional information that says “Redemption” and “Ordinary gain/loss.” On the Turbotax screen that says “Any of these less common items on your 1099-B?” I assume I should check Box 2, Gain or loss is Ordinary. Is that correct? How does checking that box affect the tax rate applicable to the loss?

[PatriciaV · Accepted solution]

Yes, check the box for Gain/Loss is Ordinary. Because the entire transaction is ordinary income, this option will have no affect on the tax rate. However, see the post below for instructions on reporting the redemption.

Per Expert DianeW:

If the OID instrument has matured and been redeemed you should use the instructions below.

The correct procedure is to adjust the basis on the sale.  In other words add all previously taxed income to the cost basis of the bond and then report the sale.

Your gain or loss is the difference between the amount you realized on the sale, exchange, or redemption and your basis in the debt instrument. Your basis, generally, is your cost increased by the OID you have included in income each year you held it. 

In general, to determine your gain or loss on a tax-exempt bond, figure your basis in the bond by adding to your cost the OID you would have included in income if the bond had been taxable. For a covered security, your broker will report the adjusted basis of the debt instrument to you on Form 1099-B.