How to Report Taxes of a Municipal Bond Bought at a Premium

by Mike Parker

One of the primary advantages of investing in municipal bonds is the steady stream of tax-exempt income. Municipalities typically issue bonds with a $5,000 face value, which is the amount the bond will be redeemed at upon maturity. But the price of the bond can vary in the open market. There may be tax consequences for buying a municipal bond at a premium and selling the bond for a different price.

Determine the purchase price of the municipal bonds. Your broker will be able to tell you whether the face amount of the municipal bond is the traditional $5,000 amount, or if the face amount is a different amount. If you paid more than the face amount for the bond, you purchased the bond at a premium. The price you paid for your bond, plus any sales charge or commission, is the cost basis for the bond.

Determine the sale or redemption price of the municipal bond. Your broker will be able to tell you the price you received when you sold your bond or when the bond was redeemed. Subtract any sales or redemption charge you paid when you sold or redeemed the bond. This is the sales price.

Subtract the sales price from the cost basis. If the result is a positive number then you have a taxable capital gain. If the result is a negative number, you have a tax deductible capital loss. If the result is zero you have neither a gain or a loss on the transaction. The transaction is still reportable for income tax purposes, but there are no tax consequences.

Determine how long you owned municipal bonds before you sold them. If you held the bonds for one year or less you must report your results as a short-term investment transaction. If you held them for more than one year, you must report your results as a long-term investment transaction.

Report short-term transactions, including the acquisition and sales dates, the cost basis and sales price, and the gain or loss on Line 1 of Schedule D, IRS Form 1040. Report long-term transactions, including the acquisition and sales dates, the cost basis and sales price, and the gain or loss on Line 8 of Schedule D, IRS Form 1040. Complete Schedule D, including any other capital gains and losses on your other investments to determine your total capital gain or loss for the tax year. Report the result on Line 13, IRS Form 1040.

Tip

  • There are no tax consequences for purchasing a municipal bond at a premium. The interest you receive from the municipal bond is usually free from federal income taxes. You may incur a tax obligation or receive a tax deduction when you sell or redeem the bond if the sale price is more or less than the price you paid for the bond.

Warning

  • Municipal bonds are not insured by any federal agency, including the Federal Deposit Insurance Corporation. Not all municipal bonds are exempt from federal income taxes. Municipal bonds may fluctuate in price on the open market. You may lose some or all of your investment. Past performance is never a guarantee of future results.

Items you will need

  • Purchase and sale price information.

About the Author

Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.