The yield on the bond is tax free, the capital gain or loss is not and on some, you may have to pay OID during the years you held the bonds if you bought at a discount.

Roberta 

If you buy it at a premium, that would likely mean that you'll be getting a better return than buying a new bond.   So let's say you buy it at  21.4k with a face value of $20k.  So if you hold it to maturity, you have a 1.4k loss and you get to keep the interest.  Nope, the IRS does not allow this.

 I had to deal with this this year as I had a bond like this called.  When you buy it, there often has interest already built up.  This is like an instant loss of embedded interest.   Unfortunately I cheated this year, my broker did all that calculations for me, so I can't detail it for you.  I had a $150 CG.  That was on my Schedule D.  My state on the other had does not allow you to take a loss or gain on the sale of MF from this state, so you'll have to check out your state's tax laws.

Simply, it is not just I bought for this and sold for that... presto chango... CG.  If you have a decent broker, you'll get all the calculations done for you.  Otherwise pull out the IRS pubs.  

jb 

Thanks all for the reponses...

So for example, I purchase a muni in the secondary markey for a premium (104). It will mature in 4 years and I will be refunded at par (100). The yield is "high" at 4% but this is why I am paying a premium for this issue.

So the 4% is tax free. For a regular (taxable) bond, I could take a cap loss (100-104) on the maturity of the bond. But what I have read in the IRS tax doc's and also JK Lassers, it sounds like the loss is not deductible. The same would be true in reverse if there was a cap gain if I bought the bond in the secondary market at a discount (no cap gain on maturity).

Thansk for working through this with me - Tony

proto123:

Thanks all for the reponses...

So for example, I purchase a muni in the secondary markey for a premium (104). It will mature in 4 years and I will be refunded at par (100). The yield is "high" at 4% but this is why I am paying a premium for this issue.

So the 4% is tax free. [...] But what I have read in the IRS tax doc's and also JK Lassers, it sounds like the loss is not deductible. The same would be true in reverse if there was a cap gain if I bought the bond in the secondary market at a discount (no cap gain on maturity).

Your description of how capital losses (e.g. purchasing at a premium and holding until maturity at par) on muni bonds are treated is correct.  No deduction, no impact.

But if a muni bond is purchased at a discount on the secondary market (i.e. not an original issue discount - OID), the gain is actually recognized as ordinary income when you sell (or when the bond matures).  The situations are not reverses of each other.

An excellent presentation of the different possibilities, along with how to declare them on your income tax schedules B and D can be found in a Fairmark forum post. They've got the descriptions exactly right, but if you'd like something more "authoritative", you could look at this page from InvestingInBonds.com, that notes: "Market discount, unlike OID, is not treated as tax-exempt interest to the holder when recognized because it arises as a result of market forces."

Thanks Freeland. This is exactly what I was looking for!  For the most part, I will usually buy at a premium.

-Tony

interesting thread.