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Zero coupon municipal bonds maturation


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Zero coupon municipal bonds maturation
The bond was slightly more than three years old when purchased and, in 1994, reporting requirements for the brokerage were not as comprehensive as they are today. I don't think that the imputed interest was reported for the first two decades or so.
Should I adjust the cost basis to include all imputed interest, meaning that the basis = the redemption price, considering that this is a Municipal bond and there should not be tax associated with the growth of my investment due to tax free interest?
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Zero coupon municipal bonds maturation
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Zero coupon municipal bonds maturation
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Zero coupon municipal bonds maturation
By way of background, I am a packrat who retained the original purchase confirmation slips from 1994 along with all of my broker's consolidated 1099s. There are Original Issue Discount (OID) sections on the 1099s, which identify OID on an annual basis dating back to 2007. In 2006 and prior years, the statements merely say "No Reportable OID" or something to that effect. (These were tax free municipal zero coupon bonds and, living in Texas, there was no state income tax).
I am relatively proficient in Microsoft Excel and used an exponential regression equation to model the OID stream of payments, achieving good correlation (to within a few cents per year). That enabled me to extrapolate OID back to 1994, when I purchased the bonds in the aftermarket.
I am a chemist, rather than an accountant. My simplified understanding is that OID is essentially an annual imputed interest which is reinvested back into the bond, much the same as reinvesting distributions from mutual funds. Both increase the basis in the holding and reduce capital gains when the investment is sold, or in the case of my bonds, matures.
After adding the imputed interest (OID) to the basis from the original confirmation slips, I ended up with a slight capital loss. I merely entered the increased basis (original purchase price + sum of annual OID) into TurboTax and everything seems to have worked out properly.
I invite correction of my interpretation, if warranted.
Michael
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Zero coupon municipal bonds maturation
the imputed (and ultimately paid out in the form of the increased sale or maturity price) interest on a tax-exempt bond is indeed tax-exempt. However, the difference between the contantly-revised cost basis (as thoroughly discussed in both answers and @msdalt01 's calculations) and the actual proceeds of selling the bond (or a call price if called) will result in possibly taxable gain or reportable loss. It is not only permissable to report the capital loss, you do yourself no favour by failing to do so.
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Zero coupon municipal bonds maturation
Presumably, if done properly, your financial services statement on account showing the zero coupon bond will present a cost basis not of your original cost but added to that each of the imputed but not received interest amounts that accumulate over the life of the bond.
The following assumes that you purchased the zero coupon bond at issue time and not in the secondary market, as you did not indicate, nor did you indicate if the cost basis was adjusted after each imputed interest accumulation.
The tax rules for zero-coupon bonds bought as new issues and held to maturity are fairly simple.
Whether the bond is taxable or tax exempt, you (or your broker) have to accrue interest on the bond. That means you have to calculate the portion of the difference between the purchase price and face value that accrued to you each tax year, even though you didn't receive any payment. The interest accrues at the interest rate you obtained when you bought the bond. Using the earlier example, if you paid $500 for a 10-year, $1,000 bond getting an interest rate of 7.05%, you would accrue $35.25 of interest in the first year.
$500 x 0.0705 = $35.25
Your adjusted issue price, or cost basis, in the bond, would then become $535.25.
$500 + $35.25 = $535.25
The following year, you would accrue $37.74 of interest.
$535.25 x 0.0705 = $37.74
And so on.
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