Negotiable bonds are securities sold by corporations, the U.S. Treasury and state or local governments to borrow money. Investors buy bonds mainly for the interest income they provide. However, negotiable bonds are traded on the over-the-counter bond market, and their prices fluctuate. This means you can have a capital gain or loss when the issuer redeems the bond. Profits that result from differences in the purchase and the sale or redemption value must be calculated separately from interest income for tax purposes.
1. Calculate the cost basis of the bond. Cost basis is the total amount of money you invested. Add all fees and transaction costs resulting from the purchase and the sale or redemption of the bond to the purchase price.
2. Subtract the cost basis from the money you receive from the issuer to redeem the bond. Normally this is equal to the face value of the bond, but not always. For example, a callable bond may be redeemed before the maturity date by the issuing corporation. You might be paid the face value plus a premium. If the cost basis is greater than the money you receive for the bond, your calculation will yield a negative number. This is the capital loss on your bond investment. If the cost basis is less than the redemption value, you will get a positive number, which means you have a gain.
3. Compare the date of purchase for the bond to the date the issuer redeemed the bond. If you held the bond longer than one year, you have a long-term capital loss or gain. If you owned the bond for one year or less, you have a short-term capital loss or gain. This is important to know because there is a significant difference between the tax treatment of short- and long-term capital gains.
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