Determining the cost basis of a bond or note bought at a discount from par value depends on two factors:
(1) whether it is TAXABLE or TAX-EXEMPT, and
(2) whether you held it until the maturity date or sold it prior to maturity (or it was called.)
For each combination of factors, the answer is detailed below. Page down until you see your particular situation:
A. If you bought a TAXABLE bond at a DISCOUNT and redeemed it at MATURITY:
Your cost basis is par value, but to arrive at that result is a three-step process for individual investors:
(1) Determine the original purchase price per bond from the trade confirmation. Do not include the accrued interest that you may have paid at the purchase date. You should have already deducted this on your Form 1040 Schedule B as a reduction of interest income in the year of purchase.
(2) Add any OID (original issue discount) interest which has been taxed to you on Form 1099 each year since you bought the bond. This is an increase in your cost basis because you paid tax on interest income which you will not receive until maturity.
(3) If the sum of steps (a) and (b) is less than par value, increase your cost basis to par value by taking the remaining difference and reporting it as taxable interest on your Form 1040 Schedule B in the year the bond matures. This difference repre- sents the market discount which is really additional interest to you over the life of the bond. It is not eligible for capital gains treatment and has to be reported as ordinary taxable interest income.
B. If you bought a TAX-EXEMPT bond at a DISCOUNT and redeemed it at MATURITY:
Your adjusted cost basis is par value.
C. If you bought a TAXABLE bond at a DISCOUNT and sold it PRIOR to maturity:
There are two possible answers in this case. Examine the description of the bond on your original trade confirmation or on your monthly brokerage account statement. If the initials "OID" appear anywhere in the description, the bond was issued with an original issue discount and you should determine your cost basis by Method A. If not, it is a "market discount" bond, and you should use Method B.
Method A. If the bond was issued with an original discount, first determine the original purchase price per bond from the trade confirmation. Do not include the accrued interest that you may have paid at the purchase date. You should have already deducted this on your Form 1040 Schedule B as a reduction of interest income.
Add any OID (original issue discount) interest which has been taxed to you on Form 1099 each year since you bought the bond. This is an increase in your cost basis because you paid tax on interest income which you will not receive until maturity.
Your cost basis is the original purchase price plus the accumulated OID.
Method B. If the bond was not issued with an original discount, first determine the original purchase price of the bond from the trade confirmation. Do not include the accrued interest that you may have paid at the purchase date. You should have already deducted this on your Form 1040 Schedule B as a reduction of interest income.
Next accrete the discount from the date of purchase to the date of sale using either the "yield to maturity" method or the "ratable accrual" method (see menu at left for explanations.) This discount accretion should all be reported as ordinary taxable interest income in the year of sale. Alternatively, in the year of purchase, you could elect to report the discount accretion as additional taxable interest income each year over the life of the bond.
Your cost basis is the original purchase price plus the accumulated discount accretion using either the "yield to maturity" method or the "ratable accrual" method (see menu items at left for detailed instructions on how to apply these methods.)
See below for our interactive tool to help you calculate your cost basis using the "yield to maturity" method.
D. If you bought a TAX-EXEMPT bond at a DISCOUNT and sold it PRIOR to maturity:
Now it gets a lot more complicated. Trust me, you want to hold your bonds to maturity if at all possible. Not only do you avoid the cost of the sales commission and the bid/ask dealer spread, but you can also avoid the following accounting nightmare (unless you are truly a glutton for punishment.)
You are required to accrete the discount over the life of the tax-exempt note or bond to determine your cost basis using the "Yield to Maturity" method. See menu at left for an explanation and example of how to do this.
Your cost basis is the original purchase price plus the accumulated discount accretions using the "yield to maturity" method.
Click on the image below to access our handy interactive tool to calculate your cost basis using the "yield to maturity" method.
Amortization Table Generator
Did we answer your question? If not, try:
Custom Search
Information provided is intended solely for U.S. individual cash-basis taxpayers and is believed to be accurate for most cases. Always consult your personal tax advisor about your own situation. Suggestions are most welcome. Please e-mail webmaster @ costbasis.com or write to us at P O Box 11022, Chicago IL 60611 with your comments.
