Settlements are taxable according to the type of income they represent.
Let's assume you paid $10,000 for the bonds, they became worthless, and you wrote them off as a bad debt or capital loss (took a $10,000 tax deduction). The settlement was $5,000. In that case, the settlement income is taxable as a long term capital gain, because it represents the price you could have gotten for the bonds, and your adjusted cost basis is zero because you already wrote it off. You would report it as a capital gain with purchase price of zero and selling price of $5,000.
Or, suppose you paid $10,000 for the bonds but you have not yet declared a loss. The settlement is $5,000. In this case you can declare a capital loss, as if you bought the bonds for $10,000 and sold them for $5,000.
Punitive damages and interest are always taxable. Suppose you paid $10,000 for the bonds, they became worthless, and you wrote them off as a bad debt or capital loss (took a $10,000 tax deduction), and the settlement is $18,000 -- $10,000 for the bonds, $5,000 punitive damages and $3,000 interest. The $10,000 for the bonds is a long term capital gain, and the $8,000 interest and punitive damages are taxed as miscellaneous ordinary income, which is a higher tax rate than capital gains.
Hope this helps.
