4.23 Sale or Retirement of Bonds and Notes

Gain or loss on the sale, redemption, or retirement of debt obligations issued by a government or corporation is generally capital gain or loss.

A redemption or retirement of a bond at maturity must be reported as a sale on Schedule D of Form 1040 (5.8) although there may be no gain or loss realized.

Corporate bonds with OID issued after 1954 and before May 28, 1969, and government bonds with OID issued after 1954 and before July 2, 1982.

If the bonds were originally issued at a discount (OID), you report your ratable monthly share of the OID element as ordinary income when the bonds are sold or redeemed; any gain exceeding OID is reported as capital gain. However, if there was an intention to call before maturity, gain is ordinary income to the full extent of the OID. A loss is a capital loss.

Corporate bonds with OID issued after May 27, 1969, and government bonds with OID issued after July 1, 1982.

The accrued amount of OID is reported annually as interest income (4.19) and added to basis; this includes the accrued OID for the year the bond is sold. If the bonds are sold or redeemed before maturity, you realize capital gain for the proceeds over the adjusted basis (as increased by accrued OID) of the bond, provided there was no intention to call the bond before maturity. If at the time of original issue there was an intention to call the obligation before maturity, the entire OID that has not yet been included in your income is taxable as ordinary income; the balance is capital gain. IRS Publication 1212 has examples for figuring the amount taxable as ordinary income.

Market discount on bonds is taxable under the rules in 4.20.

Tax-exempts.

See 4.26 for discount on tax-exempt bonds.

Obligations issued by individuals.

If you hold an individual’s note issued after March 1, 1984, for over $10,000, accrued OID must be reported annually (4.19) and added to basis. Gain on your sale of the note is subject to the rules discussed above for corporate and government OID bonds.

If the note is $10,000 or less (when combined with other prior outstanding loans from the same individual), OID is not reported annually provided you are not a professional lender and tax avoidance was not a principal purpose of the loan. On a sale of the note at a gain, your ratable share of the OID is taxed as ordinary income; any balance is capital gain. A loss is a capital loss.