Tax reporting of US Treasury Securities bought on the secondary market

[TurboLover2]

If a Treasury note (with coupons) is purchased on the secondary market for less than the maturity value, and held to maturity, should the difference be reported as interest in the year of maturity rather than a capital gain?

Also does this apply to both treasury notes and bonds (with coupons and held to maturity)?

I am pretty sure the answer is yes to both, but can someone definitely confirm?

I know it applies to treasury bills.

Thank you.

[tagteam]

Interest from a T-Bill is paid at maturity.

With respect to notes and bonds, you will have capital gain if you sell for more than your basis (purchase price).

[TurboLover2]

tagteam

Thank you, I agree and I am aware of that.

But that is not my question.

My question is about how to treat the difference between the purchase price and maturity value of coupon treasury notes and bonds bought on the secondary market and held to maturity (not about a gain on selling them).  I assume it is considered to be interest and not capital gain and I assume the entire difference should be reported in the year of maturity.

I am looking for confirmation that both of those assumptions are correct or, if not, how it should be reported.

[tagteam]

Yes, if held to maturity (not sold) the difference between the discount and par would be interest.

[TurboLover2]

Thank you tagteam.  That is what I needed.

[har3]

Would there be any benefit to selling the treasury bill a few days before maturity in order to treat the difference between purchase price and sales proceeds as a capital gain?

[Mike9241]

no capital gain. also there would likely be fees involved since it must be transferred to a financial institution to sell if held in Treasury Direct. 

To sell a bill you hold in TreasuryDirect or Legacy Treasury Direct, first transfer the bill to a bank, broker, or dealer, then ask the bank, broker, or dealer to sell the bill for you.

How you transfer a bill to a bank, broker, or dealer depends on whether you hold the bill in TreasuryDirect or Legacy Treasury Direct.

[har3]

I will be getting the periodic interest plus the par amount. How do I treat the difference between the YIELD TO MATURITY 2.925661% and the COUPON 1.37500% amount. Is that difference all interest and is any part (excluding the COUPON 1.37500%) exempt from State tax? If it is all interest Is the entire  interest reported in the year it matures, or do I have to impute any amounts over the years? Is any part capital gains?

These are from the trade confirmation.

You Bought  at 98.445312
TRADE DATE 06-17-22
SETTLEMENT DATE 06-21-22
UNITED STATES TREAS SER M-2023 NTS NOTE
COUPON 1.37500%
MATURITY DATE 06/30/2023
CURRENT YIELD 1.396700
YIELD TO MATURITY 2.925661%

Thanks

[Mike9241]

Relevant definitions are found in Sec. 1278(a). The term “bond” refers to any bond, debenture, note, certificate, or other evidence of indebtedness. “Market discount” is the excess of the stated redemption price of the bond at maturity over the basis of the bond immediately after its acquisition by the taxpayer. The term “market discount bond” refers to any bond having market discount. Market discount bonds generally do not include any bonds acquired at their original issue. Also, they do not include (1) short-term obligations that mature within one year of issuance; (2) installment obligations subject to Sec. 453B; (3) U.S. savings bonds; and (4) tax-exempt bonds purchased before May 1, 1993 (Sec. 1278(a)(1)).

you have a US T-Note that had a maturity date more than 1 year after issuance. You have held it for more than 1 year if you hold to maturity. the gain will be long-term capital gain and is subject to both federal and state taxes, unless your state exempts gains on US securities, since that gain is no longer US interest income.  

you probably will receive both a 1099-INT and a 1099-B

[TurboLover2]

So unless I am missing something it appears we have two conflicting answers here:

 tagteam said (referring to my original post here):

"Yes, if held to maturity (not sold) the difference between the discount and par would be interest."

But Mike9241 said (referring to another post but that post has the same fact pattern that my post is about):

"you have a US T-Note that had a maturity date more than 1 year after issuance. You have held it for more than 1 year if you hold to maturity. the gain will be long-term capital gain and is subject to both federal and state taxes, unless your state exempts gains on US securities, since that gain is no longer US interest income.  

you probably will receive both a 1099-INT and a 1099-B"

So that means that the difference between the discounted purchase price and par at maturity is treated as a capital gain and NOT as interest.

===

I am leaning towards 'Mike9241's answer being the correct one because of the citation he posted.  I'm thinking that  tagteam's answer is probably not right.

If true that's unfortunate because it means that if you buy a T-Note or T-Bond at a deep discount then most of your income from it will be subject to state tax.

Can anyone give a definitive confirmation of which answer is correct? 

Also, are there really any states that would exempt the gain on a treasury security bought at a discount on the secondary market and held to maturity (other than states with no income tax of course!)?  Sounds unlikely.  But would be interested in knowing if there are.

[tagteam]

@TurboLover2 

Based upon the specific facts, there will be capital gain as well as interest.

No state, of which I am aware, exempts gain on Treasury securities, only interest is exempted.

[TurboLover2]

Thanks for your reply  tagteam.

My original question was:

"If a Treasury note (with coupons) is purchased on the secondary market for less than the maturity value, and held to maturity, should the difference be reported as interest in the year of maturity rather than a capital gain?"

Your response was:

"Yes, if held to maturity (not sold) the difference between the discount and par would be interest."

To be clear, you are now changing your response to agree with Mike9241 that the difference between the discount and par will be considered a capital gain and NOT interest?  Is that correct?

[tagteam]

Yes, that is correct - not the same situation as buying Bills from T-Direct and holding them to maturity.

[TurboLover2]

Yes, I understand.   Thank you.

In a lot of cases, this kind of wipes out the advantage of not being subject to state income tax.  Many of the T Notes and Bonds on the secondary market at this time have very low coupon rates and most of their yield comes from the discount.

But with the low interest rates now, the state tax exemption on interest advantage only amounts to about 10 or 20 basis points for most taxpayers anyway.

[tagteam]

I agree.

Gain is sometimes a large component, but the states cannot tax obligations of the U.S. Government, which is essentially to pay interest on debt issued. Capital gain on the sale of those securities is a different matter.