Taxes on Treasuries in Secondary Market?

[David Donner]

Is the following correct?
-- Treasury Bills bought at auction thru a stock broker only have taxes on the interest.
-- Treasury Bills bought in the secondary market thru a stock broker have taxes on ______. I am confused. Lets say the bill was initially issued at 1% interest and rates jumped since the T-Bill you are buying on the secondary market. Do you have to pay taxes on the remaining 1% until it is due, even if it only 1/4 of the duration of the original bill? Do you have to pay taxes like cap gains on the bond since its value dropped since it was issued? How do taxes work on secondary market t-bills?

sorry for the rambling question... Its confusing.

 

[BMK]

The same basic rules apply to all bonds, whether corporate, treasury or something else. Obviously the big exception is muni bonds, because for most munis, the interest is free from federal taxation.

But with treasuries and corporate bonds, when you by a bond at a discount, and you hold it to maturity and collect the face value, you will pay tax on the difference between the price you paid and the face value.

In general, you pay tax on the interest you actually receive, when you receive it.

When you buy and sell bonds on the secondary market, you either pay or collect accrued interest, i.e., the interest is prorated because you are buying or selling the bond between interest dates. That interest is built into the sales price, so it is not taxed as interest. It becomes part of your cost basis, or sales proceeds, for determining gain or loss.

 

[kmiklas]

Tough question… you really need to ask an accountant, but here’s my 2¢:

1. Interest on Treasury issues interest is taxable only at the Federal level, so state and local taxes are not applicable.
2. Treasury issues bought at auction are only Federally taxed on the interest.
3. Treasury issues bought on the secondary market are only Federally taxed on the interest as well…. BUT…

NOW for the secondary market. If you buy a bond on the secondary market, _sell_ and make a profit, or you makes a profit at maturity, things get complex… because you’re basically flipping the bond… and The Man wants his pound of flesh.

In your example, if you hold to maturity, you are taxed on the interest received, as usual. But, if rates jumped since you bought the bill, it would be priced at a discount. If you sold, you could claim a loss.

4. If rates plunged, your bond is priced at a premium, and you sell and realize it, capital gains tax law applies. The interest is taxed at your tax bracket rate if you sell within a year, or around 15% if you hold for a year or more.
5a. If you make a profit on the sale of the bond, that is taxed at Federal, State, and Local level… because it’s not interest… it’s capital gains.
Example: you buy a bond for 98, sell for 99 and make a $1 profit. (Basically flipping it). This is taxed as capital gains at all levels. Also, If you sell for 97 and lose, this is a deductible loss up to 3000 annually.
5a. This also applies to maturity. If you bought at 98 and are returned face value of 100, for a $2 profit at maturity, this will be taxed at all levels as capital gains.
- This is a fine point that bond pros leverage. It you can pay a premium and get the same yield, you reduce your tax burden at maturity.
- Example: assume a market rate of 5%. Depending on coupon, you can pay 101 or 99 on a bond, get the same yield, and if u hold to maturity,… choose the 101. The because you will not make a profit at maturity and avoid taxes. With the 99 you bought at a discount, will make $1 at maturity, and have to pay tax on that dollar.

 

[David Donner]

Tough question… you really need to ask an accountant, but here’s my 2¢:

1. Interest on Treasury issues interest is taxable only at the Federal level, so state and local taxes are not applicable.
2. Treasury issues bought at auction are only Federally taxed on the interest.
3. Treasury issues bought on the secondary market are only Federally taxed on the interest as well…. BUT…

NOW for the secondary market. If you buy a bond on the secondary market, _sell_ and make a profit, or you makes a profit at maturity, things get complex… because you’re basically flipping the bond… and The Man wants his pound of flesh.

In your example, if you hold to maturity, you are taxed on the interest received, as usual. But, if rates jumped since you bought the bill, it would be priced at a discount. If you sold, you could claim a loss.

4. If rates plunged, your bond is priced at a premium, and you sell and realize it, capital gains tax law applies. The interest is taxed at your tax bracket rate if you sell within a year, or around 15% if you hold for a year or more.
5a. If you make a profit on the sale of the bond, that is taxed at Federal, State, and Local level… because it’s not interest… it’s capital gains.
Example: you buy a bond for 98, sell for 99 and make a $1 profit. (Basically flipping it). This is taxed as capital gains at all levels. Also, If you sell for 97 and lose, this is a deductible loss up to 3000 annually.
5a. This also applies to maturity. If you bought at 98 and are returned face value of 100, for a $2 profit at maturity, this will be taxed at all levels as capital gains.
- This is a fine point that bond pros leverage. It you can pay a premium and get the same yield, you reduce your tax burden at maturity.
- Example: assume a market rate of 5%. Depending on coupon, you can pay 101 or 99 on a bond, get the same yield, and if u hold to maturity,… choose the 101. The because you will not make a profit at maturity and avoid taxes. With the 99 you bought at a discount, will make $1 at maturity, and have to pay tax on that dollar.

Thank you very much for the detailed reply! I read it all.
It seems the most straightforward way to go is to buy a TBill at auction, and not the secondary market, thru a broker & hold until it matures and pay taxes on the interest received.

 

[countryBoy641]

Tough question… you really need to ask an accountant, but here’s my 2¢:

BUT…

- This is a fine point that bond pros leverage. It you can pay a premium and get the same yield, you reduce your tax burden at maturity.

If you are paying a premium, you are getting a lower yield. That's how ALL yields are calculated.

Also: makes no difference, whether T-Bills are bought at auction (Primary Market), or buy them on the secondary market. In other words, the "dated date" on a Treasury makes no difference. All the interest accrual is not taxable at the state (or local) level.
Capital Gains/Losses on all U.S. Treasuries are the same as all other CapGains.

Disclaimer, I passed my Series 51 (Muni Bond sales) in late 1981.
But I still remember how it works.

 

[kmiklas]

If you are paying a premium, you are getting a lower yield. That's how ALL yields are calculated.

You are getting a lower yield than par/face value, but the same yield as market price, agreed?

I make no claim to be an expert… I’m working to understand this myself.

 

[kmiklas]

Thank you very much for the detailed reply! I read it all.
It seems the most straightforward way to go is to buy a TBill at auction, and not the secondary market, thru a broker & hold until it matures and pay taxes on the interest received.

- Yes, to buy at auction and hold to maturity, from Treasury Direct or your broker is simplest. It’s also equally simple to buy on the secondary market.
- The complexity comes in when you start buying and selling, flipping these bonds, and “working” the market, and profiting from the price moves.