Redemption of US Treasury Notes

[Amy (biznester)]

Hi. I have slept many nights since my last exposure to bonds and notes, and would be mucho appreciative of some help.

Client has a 1099-B with gross proceeds from 3 treasury notes. All matured in 2007. I've traced back through the brokers statements for these numbers:

Note A - bought 2003 $10,142 (accrued interest paid on purchase $62); interest income earned and reported every year held; 2007 1099-B sale amount $10,000.

Note B - bought 2005 $49,705 (accrued int $348); interest income earned and reported in 2006; 2007 1099-B sale amount $50,000.

Note C - bought 2005 $34,895 (accrued int $179); interest income earned and reported in 2006; 2007 1099-B sale amount $35,000.

My question is how to arrive at the basis for gain or loss on D. Can I add the accrued interest paid to the basis, or is it just sale price less purchase price?

Thanks very much,

Amy

[indyscott]

previously tax accrued interest increases the basis.

[Amy (biznester)]

Thanks for replying and trying to help me out, indyscott.

"Set the Wayback Machine to 1977, Sherman."

"Yes, sir, Mr. Peabody."

1977 was the year I took Intermediate Accounting in college, so the connectors are old, but I do seem to remember that Treasury notes were set up as such that when you did pay accrued interest at purchase, you got it returned to you in your interest income payments, 100% of which were taxed as income. So, that means I should add the accrued interest to the purchase price of each note.

I think??????

Does that sound wrong to anyone? Indyscott, is that what you meant?

Again, mucho thanks. I lurk a lot, so please excuse my not posting much. I have arthritis in my fingers so I tend to lurk unless I'm having a pain free day.

[Maribeth]

The treasury notes are not savings bonds. They are issued at face value and the interest is paid to taxpayer every six months.

This is what I believe your basis is:

Note A - bought 2003 $10,142 - accrued interest of 62 = 10080

Note B - bought 2005 $49,705 - accrued interest of 348 = 49,357

Note C - bought 2005 $34,895 - accrued interest of 179 = 34,716

Maribeth

[Amy (biznester)]

Hi, Maribeth and thanks for trying to help. That said, I am confused now. You're saying I need to back the accrued interest out of the purchase price that is on the broker statement?

I just found this on the Treasury Direct website and thought it had confirmed adding it to the purchase price. Would you mind reading it and then plunk me on the noggin so maybe this will sink in, lol?

Treasury Notes: Rates & Terms http://www.treasurydirect.gov/indiv/research/indepth/tnotes/res_tnote_rates.htmIt says "Sometimes when you buy a Note, you are charged accrued interest, which is the interest the security earned in the current interest period before you took possession of the security. If you are charged accrued interest, we pay it back to you as part of your next semiannual interest payment.

For example, you buy a 10-year Treasury Note issued August 15, 2005 and maturing August 15, 2015. If August 15, 2005 fell on a Saturday, Treasury would issue the Note on the next business day, Monday August 17, 2005. Besides the purchase price, you would pay Treasury for the interest accrued from August 15 to August 17, 2005. When you get the first semiannual interest payment, it will include the accrued interest you paid."

I am assuming that the accrued interest paid was part of the taxable interest reported on client's 1040 while the note was maturing, so it's already had tax paid on it, no? So, why take it out of the purchase price?

Thoroughly confused here, but I've been that way before and will be again....

THANKS,

Amy

The treasury notes are not savings bonds. They are issued at face value and the interest is paid to taxpayer every six months.

This is what I believe your basis is:

Note A - bought 2003 $10,142 - accrued interest of 62 = 10080

Note B - bought 2005 $49,705 - accrued interest of 348 = 49,357

Note C - bought 2005 $34,895 - accrued interest of 179 = 34,716

Maribeth

[Maribeth]

What should have happened on the tax return in the year that the bond was purchased, is that the accrued interest paid was subtracted from the actual interest received. When you buy a bond between interest dates you usually have to reimburse the seller for the amount of interest that they had earned but had not yet received.

So you buy a bond for 10,000 with accrued interest of 200 for a total of $10,200. A couple of months later you receive the interest payment and it is for $400. On your tax return for that year you would report $400 interest received, less interest paid of $200 for a net amount on Schedule B of $200.

hth,

Maribeth

[jklcpa]

The accrued interest pd at prch should have been reported as a negative on Sch B in the year of prch, so no taxes should have been paid on that interest. That way the TP should have only paid taxes on the interest for the period that the bond was actually owned. The Sch B instructions cover this. Read the instructions for Line 1 Interest Income under the heading "Accrued Interest." The reason a buyer pays accrued interest at purchase is because at the next int payt date, the buyer will receive the full 6 mos interest, even though the bond didn't belong to him/her for the full six mo period. The accrued interest isn't part of basis.

ETA: Agree with Maribeth. I just need to type faster, or not at the same time. :)

[Amy (biznester)]

Ok, I see that, but it was not done that way. No interest was deducted. The interest reported on Schedle B was not net of the accrued interest. The broker statement just had it listed separately in a section that was not being reported to the IRS.

So, that is why I am wanting to add it to the basis now, at redemption.

[Amy (biznester)]

Ok, Emily Latilla here. Never Mind, I see where I'm screwing up, I think.

I went back and added up the cash outflow on the broker statements in the purchase years. It appears that the purchase price totals I'm using as basis INLCUDE the accrued interest paid. So, I should not add it in again.

NOW, whether or not the broker subtracted it from the interest income once interest was paid is something I cannot determine.

To be safe, I will just take 1099-B redemption price less that purchase price and not include the accrued interest at all.

[Amy (biznester)]

Thanks jklcpa and Maribeth, I'll just do what you both advise. Sorry, I only saw Maribeth's reply. I guess I should assume the broker took the a.i. out of the amount it showed as interest income, and that's what the Treasury Direct means as returning it back to the note holder.

Thanks much, sorry if I was frustrating, I'm sure I was, it's just not making sense to me.

[jklcpa]

Your basis should not include the accrued interest pd at prch. The basis is the price of the bond and any fees for making the trade.

Concerning the interest income in the year of purchase: the broker issues the 1099-INT for the gross amount paid and it's up to the TP to report the accrued interest pd at prch as a negative on Sch B, so the Sch B in the year of prch should net out to the interest income for the period the bond was actually owned.

Example:

10K 5%bond pays int 6/1 & 12/1.

Bond purchased on 7/1 for face plus $75 in commissions & fees.

Total cash outlay is $10116 calc'd as follows:

Face of $10000

Fees $75

Accr'd int pd at prch $41

In year of prch, TP collected $250 of interest on 12/1, which is for the entire 6 mos even though he owned it for only 5 mos. 1099-INT for the year of prch will report the full $250, but the TPs Sch B for the year of purchase should report the $250 on one line & then subtract (as a negative) the $41 accrued int pd. So he really only paid tax on $209 of interest.

So then the bond or note is redeemed for face and TP pays another fee of $75. His basis is $10000 plus the orig fee at purch and the fee to sell. His total basis & selling expenses in the example = $10,150 (10000 + 75 + 75). So TP has a loss of $150.

[Amy (biznester)]

Yes, thank you, jkl. That's 100% textbook correct. And I get it. It's just that real life isn't playing out as well. I am sitting here with the ye broker statements and the prior year returns and know that the accrued interest was not subtracted from the 1099-INT reported amounts.

But, whatever. I'll ere on the side of caution then and just subtract the purchase price from the sale price to compute gain.

Thanks again, very much. I appreciate the thoughtfulness. Taxpayer told me just get it filed. I appreciate the review of this, next time I'll know what questions to ask, LOL. And to deduct the accrued interest from interest income if I ever see that in the year of purchase.

[rickart]

Would somebody out there who has more working gray cells than I do, address the question of whether there shouldn't have been OID taken (or reported on a 1099 OID) for the bond bought for significantly less than face value. I think (?) that the accrued interest issue is different (and *has* been addressed above. [if OID, which is reported as interest on Sch. B, has been recognized (though not received), it steps up the TPs basis, I believe.]

Good luck all

One more crisis day....

regards,

Rick, EA, Tucson

[jklcpa]

You can treat the OID as considered de minimus if the OID is less than 1/4 of 1% (.0025) of the face of the note multiplied times the # full yrs from date of orig issue to maturity. If determined to be de minimus, then OID can be ignored.

In Biznester's facts, then as long as Note B had an orig term of > 5 yrs and Note C had an orig term of > 3 yrs, then OID is de minimus and ignored.

Pub 550 has examples.