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TurboLover2
Level 3

Tax reporting of US Treasury Securities bought on the secondary market

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.

1 Best answer

Accepted Solutions
TurboLover2
Level 3

Tax reporting of US Treasury Securities bought on the secondary market

==UPDATE==

Having seen no response to my post below I am marking it (my own answer) as the best answer.

=========

 

I am again questioning whether the answers given to my question are correct. 

 

From IRS Publication 550:

 

"Market Discount Bonds
A market discount bond is any bond having
market discount except:
• Short-term obligations (those with fixed
maturity dates of up to 1 year from the date
of issue),
• Tax-exempt obligations you bought before
May 1, 1993,
• U.S. savings bonds, and
• Certain installment obligations.
Market discount arises when the value of a
debt obligation decreases after its issue date.
Generally, this is due to an increase in interest
rates. If you buy a bond on the secondary market, it may have market discount."

 

THEN IT SAYS:


"When you buy a market discount bond, you
can choose to accrue the market discount over
the period you own the bond and include it in
your income currently as interest income. If you
do not make this choice, the following rules
generally apply.
• You must treat any gain when you dispose
of the bond as ordinary interest income, up
to the amount of the accrued market discount. See Discounted Debt Instruments

..."

 

https://www.irs.gov/pub/irs-pdf/p550.pdf 

see pages 14 and 15

 

===

 

So this is a "Market Discount Bond" and according to how I read the IRS rule relating to market discount bonds the gain is treated as ordinary interest income, NOT as a capital gain.

 

So it appears to me the answers that were given in this thread are incorrect.  And also, since the gain is treated as ordinary interest income that the state tax income exemption is preserved.

 

I welcome any correction or validation of my understanding but it appears to me that the previous answers were wrong.

View solution in original post

16 Replies
tagteam
Level 15

Tax reporting of US Treasury Securities bought on the secondary market

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
Level 3

Tax reporting of US Treasury Securities bought on the secondary market

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
Level 15

Tax reporting of US Treasury Securities bought on the secondary market

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

TurboLover2
Level 3

Tax reporting of US Treasury Securities bought on the secondary market

Thank you tagteam.  That is what I needed.

har3
New Member

Tax reporting of US Treasury Securities bought on the secondary market

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
Level 15

Tax reporting of US Treasury Securities bought on the secondary market

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
New Member

Tax reporting of US Treasury Securities bought on the secondary market

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
Level 15

Tax reporting of US Treasury Securities bought on the secondary market

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
Level 3

Tax reporting of US Treasury Securities bought on the secondary market

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
Level 15

Tax reporting of US Treasury Securities bought on the secondary market

@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
Level 3

Tax reporting of US Treasury Securities bought on the secondary market

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
Level 15

Tax reporting of US Treasury Securities bought on the secondary market

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

TurboLover2
Level 3

Tax reporting of US Treasury Securities bought on the secondary market

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
Level 15

Tax reporting of US Treasury Securities bought on the secondary market

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.

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