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September 4, 1982, or you acquired them before March 2,
1984, treat your part of OID as tax-exempt interest. To fig-
ure your gain or loss on the sale or trade of these bonds,
reduce the amount realized by your part of OID.
If the bonds were issued after September 3, 1982, and
acquired after March 1, 1984, increase the adjusted basis
by your part of OID to figure gain or loss. For more infor-
mation on the basis of these bonds, see Discounted
tax-exempt obligations, earlier in this chapter.
Any gain from market discount is usually taxable on dis-
position or redemption of tax-exempt bonds. If you bought
the bonds before May 1, 1993, the gain from market dis-
count is capital gain. If you bought the bonds after April
30, 1993, the gain from market discount is ordinary in-
come.
You figure market discount by subtracting the price you
paid for the bond from the sum of the original issue price
of the bond and the amount of accumulated OID from the
date of issue that represented interest to any earlier hold-
ers. For more information, see Market Discount Bonds in
chapter 1.
A loss on the sale or other disposition of a tax-exempt
state or local government bond is deductible as a capital
loss.
Redeemed before maturity. If a state or local bond
issued before June 9, 1980, is redeemed before it ma-
tures, the OID is not taxable to you.
If a state or local bond issued after June 8, 1980, is re-
deemed before it matures, the part of OID earned while
you hold the bond is not taxable to you. However, you
must report the unearned part of OID as a capital gain.
Example. On July 2, 2012, the date of issue, you
bought a 20-year, 6% municipal bond for $800. The face
amount of the bond was $1,000. The $200 discount was
OID. At the time the bond was issued, the issuer had no
intention of redeeming it before it matured. The bond was
callable at its face amount beginning 10 years after the is-
sue date.
The issuer redeemed the bond at the end of 11 years
(July 2, 2023) for its face amount of $1,000 plus accrued
annual interest of $60. The OID earned during the time
you held the bond, $73, is not taxable. The $60 accrued
annual interest is also not taxable. However, you must re-
port the unearned part of OID, $127 ($200 − $73), as a
capital gain.
Long-term debt instruments issued after May 27,
1969 (or after July 1, 1982, if a government instru-
ment). If you hold one of these debt instruments, you
must include a part of OID in your gross income each year
you own the instrument. Your basis in that debt instrument
is increased by the amount of OID that you have included
in your gross income. See Original Issue Discount (OID) in
chapter 1.
If you sell or trade the debt instrument before maturity,
your gain is a capital gain. However, if at the time the in-
strument was originally issued there was an intention to
call it before its maturity, your gain is generally ordinary in-
come to the extent of the entire OID reduced by any
amounts of OID previously includible in your income. In
this case, the rest of the gain is capital gain.
An intention to call a debt instrument before maturity
means there is a written or oral agreement or understand-
ing not provided for in the debt instrument between the is-
suer and original holder that the issuer will redeem the
debt instrument before maturity. In the case of debt instru-
ments that are part of an issue, the agreement or under-
standing must be between the issuer and the original
holders of a substantial amount of the debt instruments in
the issue.
Example 1. On February 9, 2022, you bought at origi-
nal issue for $7,600, Jones Corporation's 10-year, 5%
bond which has a stated redemption price at maturity of
$10,000. On February 13, 2023, you sold the bond for
$9,040. Assume you have included $334 of OID in your
gross income (including the amount accrued for 2023)
and increased your basis in the bond by that amount. Your
basis is now $7,934. If at the time of the original issue
there was no intention to call the bond before maturity,
your gain of $1,106 ($9,040 amount realized minus
$7,934 adjusted basis) is capital gain.
Example 2. If, in Example 1, at the time of original is-
sue there was an intention to call the bond before maturity,
your entire gain is ordinary income. You figure this as fol-
lows:
1. Entire OID ($10,000 stated redemption price at
maturity minus $7,600 issue price) .......... $2,400
2. Minus: Amount previously included
in income ..........................
334
3. Maximum amount of ordinary income ......... $2,066
Because the amount in (3) is more than your gain of
$1,106, your entire gain is ordinary income.
Market discount bonds. If the debt instrument has mar-
ket discount and you chose to include the discount in in-
come as it accrued, increase your basis in the debt instru-
ment by the accrued discount to figure capital gain or loss
on its disposition. If you did not choose to include the dis-
count in income as it accrued, you must report gain as or-
dinary interest income up to the instrument's accrued mar-
ket discount. See Market Discount Bonds in chapter 1.
The rest of the gain is capital gain.
However, a different rule applies if you dispose of a
market discount bond that was:
•
Issued before July 19, 1984; and
•
Purchased by you before May 1, 1993.
In that case, any gain is treated as interest income up to
the amount of your deferred interest deduction for the year
you dispose of the bond. The rest of the gain is capital
gain. (The limit on the interest deduction for market dis-
count bonds is discussed in chapter 3 under When To De-
duct Investment Interest.)
Report the sale or trade of a market discount bond in
Form 8949, Part I or Part II, whichever is appropriate. Use
the table How To Complete Form 8949, Columns (f) and
(g) in the Instructions for Form 8949 to help you figure the
Publication 550 (2023) Chapter 4 Sales and Trades of Investment Property 75