A few steps to elucidate this one. First, think through the municipal bond market. When local governments need to fund projects (schools, community centers, chains of massage parlors, etc.) they issue bonds to pay for them. These are called municipal bonds, or muni bonds to their close friends and family.
These muni bonds have some market advantages compared to other fixed income investments (like corporate bonds, which carry full tax loads as opposed to muni bonds which are tax favored). Interest on muni bonds is exempt from federal (and most state) taxes.
Okay, we’re not quite there yet. Now a few words on bond pricing in general. When bonds are issued, they are sold at a certain price (based on the structure of the bond...like maturity date, interest rate, etc.). This initial price is know as "par."
From there, a bond’s price will move around, based on how overall rates look. A high-rate bond increases in value (sells above par) when overall rates fall. It becomes more valuable because you can get a better rate with that bond than new bonds being issued at the lower prevailing rates. And vice versa. A bond will sell below par in a rising rate environment.
If you buy a muni bond below par and hold onto it, you make a profit on that difference. But unlike the interest on the muni bond, you need to pay taxes on that profit.
Okay, we’re finally ready for the De Minimis Tax Rule. This determines whether this profit is taxed at the individual income level or the (usually lower) capital gains level. Basically, there is a line set by the rule. If the profit is below a certain amount (set by the rule, hence the catchy name "minimis"), the profit gets taxed as income. A profit above the line receives capital gains treatment.
Related or Semi-related Video
Finance: What is Tax Basis?8 Views
Finance allah shmoop What is tax basis Well your basis
is your cost Your costs for assessing how much you
owe when the tax man coming you bought a thousand
shares of whatever dot com at twelve bucks a share
in its eye po and huzzah Three years later the
stock is at thirty You decide whatever dot com is
now passe because a kardashians said so it'll be over
taken by whenever dot com and you want to sell
So you dio and you live in a thirty percent
marginal tax blue state And that is your federal tax
rates in twenty percent But then you add in ten
percent for state taxes and whatever's left for obamacare and
you pay about thirty percent tax on your gains Well
you paid twelve grand to buy the stock and after
the sale you took in thirty grand when you sold
it for a gain of eighteen thousand dollars Your tax
basis on those shares is twelve grand so you pay
thirty percent tax on the eighteen grand of gain or
fifty four hundred dollars to net from the sale of
thirty thousand dollars worth of stock How much Yeah twenty
Four thousand six hundred dollars He fancy math Had you
just gotten those shares free I'ii they were gifted to
you and you had no tax basis or a tax
basis of zero dollars a share Well then your gain
would have been from zero to thirty grand or a
gain of thirty thousand dollars to then be taxed at
thirty percent or nine grand in taxes to net just
twenty one thousand dollars after the sale So having ah
high tax basis or at least being able teo point
toe one saves you money when the tax man coming
and well that's pretty much it alright he's gone Now
you can all come out Come on it's Okay it's 00:01:53.698 --> [endTime] safe
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