sales and ordinary income

[Kram BergGold]

I have learned that the gain from the sale of bonds bought at a discout after 1993 is ordinary income. This seems to apply to tax exempt bonds as well as taxable bonds. Question, is the ordinary incomed reported on Schedule B as interest or some other way?

Also I read an article on gains and losses from foreign bonds with gain or loss due to currency fluctuation. This to is ordinary income. Any idea where to report the ordianry gain or loss? I am thinking Form 4797 but it is for business property which this is not.

Lastly, The article did not mention foreign stock sales just bonds. Any idea if this applies to stocks sold in a foreign brokerage account?

[Golden Rocket]

Schedule D

BergGold, I disagree with reporting ordinary income on the sale of a bond. I believe the only thing that is ordinary income is the amount of the discount, and this small amount is taken into income over the life of the bond.

I believe foreign transaction costs (translation, money-changers, currency fluctuations, etc.) are all buried into the cost of the security and reported in their U S Dollar equivalents.

A 5 year, $10,000 bond is purchased for $9500. The $500 is ordinary income, but is spread over the five year life. A compound-interest formula is used to amortize this $500.
Let's assume Yr. 1 amortization is $175.00. In Year 1, the bondholder reports $175.00 in ordinary income on Schedule B. The $175 is in addition to any other taxable income paid by the bond issuer. However, when he does this, the "basis" of the bond has now become $9675. Furthermore assume that in year 2, the issuer redeems the bond for $10,000. The bondholder reports $10,000 on Schedule D as the sales amount, and $9675 as cost, thus reporting a $325 long-term capital gain.

Mark and other readers, please correct me if I'm wrong.

[Kram BergGold]

Bond premium

Golden Rocket, amortization applies to bond premium (amounts paid above par) not bond discount.

[gordman]

You are right here, you should focus on this thing.

[New York Enrolled Agent]

BergGold, I disagree with reporting ordinary income on the sale of a bond. I believe the only thing that is ordinary income is the amount of the discount, and this small amount is taken into income over the life of the bond.

Rocket

Generally, a taxpayer WILL report gain attributable to market discount on the sale of a bond as ordinary income. The taxpayer MAY elect under §1278(b) to include the the annual market discount income as interest but it takes an affirmative election.

[Roland Slugg]

An important exception

The "market" discount is zero if it is less than 0.25% of the stated redemption value of the bond at maturity times the number of years to maturity from the date the bond is acquired. (IRC §1278(a)(2)(C))

For example, if a $25,000 bond maturing on 3/1/25 was purchased, say, on 10/15/07 for $24,000, there is no "market discount" because $25,000 × 0.25% × 17.375 (years) = $1,085. Since the actual discount of $1,000 is less than this amount, the "market discount" is $0. However, if that bond had cost $23,900 instead of $24,000, the "market discount" would be the full discount received ... $1,100. It's an all-or-nothing calculation.

The "market discount" is taxable as interest even in the case of T/F munis. It's also true that the incremental "market discount" may be taxable on an annual basis if the required election is made, as mentioned by NYEA above.

[RJM]

Thanks for the details Roland... I need to review these rules in more detail. I am sure I have mis-reported this in the past.