How to handle both interest and capital gains on US Treasury Notes purchased at a discount

[mgreen10]

In 2024, I made several purchases of US Treasury Notes that matured in about 6 months,  9 months, and 12 months. My understanding is that these notes are purchased at a discount (less than face or par value) and pay back at face value at maturity. The difference is the interest you earn, reported on a Form 1099-INT.

That seemed to be true for some of the Notes but not for others. For some, I also received a Form 1099-B showing short-term capital gains. Fidelity told me this is because I purchased the bonds at a discount. But all US Treasury Notes are purchased at a discount.  Here are the details for two groups of Notes purchased.

Date	Qty	Price	Princ Amt	Accrued Int	Stlmnt Amt	Coupon	Mat Date
1/29/2024	13	97.5510	12681.63	0	12681.63	zero	7/25/2024
1/29/2024	50	96.7420	48371	62.84	48433.84	1.00%	12/15/2024

The $13K notes paid interest and had no capital gains. The $50K notes paid interest and generated capital gains on a Form 1099-B.  For the $50K group, the 1099-B shows Total proceeds of $50,000 and Cost Basis of $48,433.84. Why doesn't the $13K group have a 1099-B showing $13,000 and $12,681.63 for the Proceeds and Basis. This seems inconsistent.

Why do some Notes have capital gains and others don't?

For the $50K group, do I pay taxes on both the interest and capital gains?

Thank you

[DaveF1006]

 The difference depends on if the notes are Original Discount Notes (OID) or Market Discount notes. 

1. OID notes ‌purchased directly from the Treasury at a discount (e.g., zero-coupon bonds) typically report the difference between the purchase price and face value as interest income on Form 1099-INT. This seems to apply to your $13K notes. In this case, there was no interest paid.
2. Market Discount ‌notes purchased on the secondary market at a discount may generate capital gains if sold or redeemed. The $50K notes likely fall into this category, which is why you received a Form 1099-B. The gain is treated as a capital gain because the discount is considered a market discount rather than an OID.
3. Interest Income: The accrued interest (e.g., $62.84) is reported on Form 1099-INT and taxed as ordinary income. Also 

Capital Gains: The difference between the settlement amount ($48,433.84) and the face value ($50,000) is reported on Form 1099-B as a short-term capital gain. You would pay taxes on both the interest and the capital gains.

The reason you didn't receive a 1099B for the OID notes is because there was no interest paid on them. It appears you redeemed these at face value.

[baldietax · Accepted solution]

The 13k are presumably T-Bills which are specific short term instruments that are reported as interest on 1099-INT Box 3.

The 50k Notes do not generate capital gains you should have an "Accrued Market Discount" (AMD) adjustment on the 1099-B in Box 1f which will zero out the capital gain and report this amount on your Schedule B as ordinary income, not a capital gain.

2 issues to be aware of:

- if the 1099-B is input as sales summary only with adjustment you will be asked to send your 1099-B to IRS.  You can avoid this by inputting these sales as "one by one" with the detail which will generate Form 8949, and put the balance of your 1099-B in as sales summaries, it will all be consolidated on different rows of Schedule D and no mailing should be required.  Same for any other adjustments for wash sales, non covered securities etc.

- the AMD from Box 1f will not automatically flow to your state return as a subtraction to income the same way 1099-INT Box 3 does.  There are various ambiguities and differing language in the tax code state by state as to whether AMD is exempt from state taxes or not, some states are clearer than others either way.  There is a long running thread on this topic here 

https://ttlc.intuit.com/community/taxes/discussion/re-accrued-market-discount-on-treasury-bonds-stat...

[mgreen10]

I realized that you are correct--the $13K is US T Bills, not notes, with the interest reported on 1099-INT box 3. The $50K is US Treas Notes.  The Notes were purchased on the secondary market and had accrued interest. The amount I paid for them included this accrued interest.

How do I handle the accrued interest in Turbo Tax? Do I make an adjustment to (reduce) the amount reported in 1099-INT box 3 by that amount? Or do I make an adjustment to (increase) the cost basis in 1099-B box 1e by that amount?

In the state tax (California) portion of Turbo Tax, I then need to make adjustments to remove all of this U.S. Treasury debt income. I think it will be clear how to do that when I get there but if you have any tips, please let me know.

Thank you!