Municipal Bond Forum
Maturing zero coupon bonds
Q
You received an e-mail from “P.W.” on 2/9/05 regarding the need to report a maturing tax- free zero coupon bond to the IRS. The 1040 schedule in which capital gains are reported asks for purchase and selling prices of a security. How should the tax filer make clear that the bond was a tax-free muni zero and, therefore, no tax is due even though there was a difference between the purchase and selling prices? Also, in your response to P.W., you stated, “Based on the original cost, munis can be subject to capital gains.” Can a tax-free zero muni be subject to capital gains? If so, how would this be calculated?
A
James A. Klotz responds:
If your zero coupon bond was purchased at the time of issuance, the tax-free interest earned on the zero coupon municipal bond acts to increase your cost basis in the security. Your adjusted cost at maturity would then be equal to the redemption price, which indicates no tax is due.
If the zero coupon bond is purchased after issuance, below its accreted value, the difference between the adjusted cost basis and the redemption price could be subject to capital gains tax.
Please consult your tax advisor for a definitive answer regarding your specific situation.
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