Municipal Bond Forum

I just discovered your site and find it very interesting. But with regard to your “Lessons in Laddering” article, my understanding is that accreted market discount is taxable at ordinary income rates when a bond is sold, even for municipal bonds. In your example, when the discounted bonds bought in the swap at 50 mature at 100, ordinary income tax will be owed on the $100,000 gain. Therefore the tax loss of $100,000 resulting from the swap will be offset by $100,000 of accreted market discount at maturity. If the tax loss is used to offset capital gains, then the investor is only saving 15% ($15,000) in taxes at the time of the swap, but will owe anywhere up to 35% ($35,000) taxes on the accreted market discount at maturity, presumably 20-plus years after the swap. You state: “Best of all, the investor’s new bonds regained all of their lost market value in the following years,” but you don’t mention this tax liability. Admittedly, if the investor reinvested the $15,000 tax savings, and his tax rate were less than the maximum 35%, he might still come out ahead, but it pretty much seems a wash. Am I missing something?

H.B.

I’ve been reading up on zeros and taxes and such and have a question: With tax-exempt municipal zeros, are taxes due annually as zeros accrete, even though they are tax exempt? There seems to be some differing opinions about this.

T.C., New York

In your reply to the e-mail below, Residency and interest, you state: “Any state with an income tax will tax the interest on ‘out-of-state’ bonds. Naturally, states without income taxes don’t tax bond interest of any kind.” Your answer is not entirely accurate. New Hampshire doesn’t have a personal income tax, but it does tax the interest earned on municipal bonds from other states (but not on New Hampshire muni bonds). This may hold true for other states that do not tax earned income but do levy a tax on residents who earn interest from out-of-state muni bonds.

P.C., Massachusetts