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    Municipal bond acquisition premium

    Customer's brokerage 1099 shows one of his holdings to be an individual tax exempt bond. (Double tax exempt in my state).
    On the bottom of the form, amounts are shown for "Original issue discount" and "Acquisition premium noncovered".
    As I understand, the OID is treated as tax exempt interest but how does one handle the acquisition premium shown.
    Thanks for comments.



    #2
    Are you referring to an entry on Line 13 of Form 1099-INT, or to something else?
    The problem I am having is where the investment firm is showing a number for "Cost or other basis" on Line 1e (Code D) of Form 1099-B, but then in the right margin of that information shows a LARGER amount, labeled "Original Basis." I feel I should report the sale/purchase prices exactly as shown on the Form 1099-B, most especially with Code D involvement.
    Of course, when I try to get any explanation from the brokerage firm, they always hide behind the tried and true "We don't offer any tax advice."
    As noted by the OP, this issue is most frequent when dealing with tax-exempt income. Things become even more annoying with muni funds where you have to pull out the pieces of the various income/adjustments that apply only to the client's home state.
    I will eagerly monitor this thread for advice from others who may have encountered these identical scenarios!

    FE

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      #3
      As I understand it, only the stated interest on a municipal bond is tax exempt. If the original issue discount is amortized, that becomes taxable interest income. If the bonds are sold or redeemed, the profit is taxable or the loss is deductible as capital gains....

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        #4
        Municipal bonds have a face value. When sold for more of the face value, they are sold with a premium; when less than face value, a discount. During the life of the bond, the premium amount is amortized and reduces the amount of t/e interest income received. The discount is also amortized and increases the amount of t/e interest income received. For a real simple example, just to show the numbers, if a one-year-only 5% bond was sold at a premium, at the beg of the year, face value $1000, amt paid $1050. At the end of the year, the bond holder received $50 in interest income, amortized the premium for a reduction of $50, with net t/e interest income of zero. And then the bond was redeemed for $1000. The bond holder has received his entire investment back. No capital gain or loss (which would have been taxable). (very simple example here)

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          #5
          Originally posted by Maribeth View Post
          Municipal bonds have a face value. When sold for more of the face value, they are sold with a premium; when less than face value, a discount. During the life of the bond, the premium amount is amortized and reduces the amount of t/e interest income received. The discount is also amortized and increases the amount of t/e interest income received. For a real simple example, just to show the numbers, if a one-year-only 5% bond was sold at a premium, at the beg of the year, face value $1000, amt paid $1050. At the end of the year, the bond holder received $50 in interest income, amortized the premium for a reduction of $50, with net t/e interest income of zero. And then the bond was redeemed for $1000. The bond holder has received his entire investment back. No capital gain or loss (which would have been taxable). (very simple example here)
          Thank you for the excellent explanation.

          As a specific sale for this client: From 1099-B (Code D) Proceeds = $15,000.00, Cost basis = $15,000 and in right margin "Original basis $16,547.70 -- Redeemed" (The client has several other muni bond sales where the purchase / sale prices on the 1099-B are not full of zeros. They also show "Original basis" amounts greater than the reported cost basis used for Sch D purposes.
          I will therefore report on Sch D NO net gain/loss for this event and will assume the remainder has been previously worked out in numbers provided for the Tax-exempt Interest" line on Form 1040. Am I close?

          FWIW, although I cannot track the investments of a client, I have noted a similar "Original basis" note for sale of some non-muni assets. As best I can tell, perhaps they are showing cumulative cost basis adjustments for returns of capital which are now automatically included with *broker* cost basis records.

          Thanks again for taking the time to explain!

          FE

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