USA Capital Loss Tax treatment for called municipal bond

[Shelly]

Municipal bonds were purchased on 10/2/09 for $111.43. The maturity date was 10/1/18 but they were called on 1/3/14 for $100. What is the amount of the tax loss if $25,000 of par was purchased?

 

[bobAnInvestorNJ]

Municipal bonds were purchased on 10/2/09 for $111.43. The maturity date was 10/1/18 but they were called on 1/3/14 for $100. What is the amount of the tax loss if $25,000 of par was purchased?

When you say Municipal bonds, I am assuming you mean tax free bonds. As such, if you want to take a loss on them for tax purposes, you need to the add the interest that you received (and did not pay tax on) to the cost basis. As such, I am guessing that you do not have a tax deducible loss in this case. What was the coupon rate of the bond?

 

[Shelly]

Thanks for your response.
The coupon was 5% but I'm not sure that makes any difference. The bond was a tax free municipal bond. However, when it was purchased the expectation was that, for the premium price paid of $111.43 the bond would pay the 5% interest per $100 until the maturity date of 10/1/18. Instead, the bond paid the 5% until it was called on 1/3/14. If the bond was priced at the point of sale knowing it would only pay the interest until 1/3/14 the price would have been much less than $111.43. I think it would have been something like $106 because, instead of running for the expected approximately 9 years, it only ran for approximately 5 years, or a little more than 50% of the expected time. Therefore, would not the difference between the price paid and the price that would have been paid knowing the actual remaining life of the bond be a capital loss.

 

[bobAnInvestorNJ]

Thanks for your response.
The coupon was 5% but I'm not sure that makes any difference. The bond was a tax free municipal bond. However, when it was purchased the expectation was that, for the premium price paid of $111.43 the bond would pay the 5% interest per $100 until the maturity date of 10/1/18. Instead, the bond paid the 5% until it was called on 1/3/14. If the bond was priced at the point of sale knowing it would only pay the interest until 1/3/14 the price would have been much less than $111.43. I think it would have been something like $106 because, instead of running for the expected approximately 9 years, it only ran for approximately 5 years, or a little more than 50% of the expected time. Therefore, would not the difference between the price paid and the price that would have been paid knowing the actual remaining life of the bond be a capital loss.

From a tax point of view the fact the bond got called earlier does not seem relevant to me. Based upon what I understand, and I could be wrong, since you got all your money back (interest payment received + principal) you do not have a capital loss for tax purposes. If you tell me you think the tax code is unfair in this area, I will not argue. It would also be a good idea to check with a CPA who is knowledgeable in the tax code.