Market Discount

“Oh boy,” we exclaim, rubbing our hands together gleefully. We just bought a bond for $600 that was originally issued for $1,000. What a steal, what a deal.

When this happens—when there’s a difference between a bond’s sale price and its redemption price—that’s what’s known as a “market discount,” and discounts like these can make the savvy investor nice little chunks of change.

But buyer beware: market discounts come with more tax rules than a convoluted D&D game. For example, that $400 we saved on that bond purchase? We need to report it as interest income and pay the applicable taxes on it. Unless the bond was issued prior to 1993, in which case we need to pay capital gains taxes on it instead. Or, if it’s a United States savings bond we’re talking about, it's exempt. No tax payment needed. Or, if the market discount is less than .25% of the bond’s value—that’s point two-five, not twenty-five percent, BTW—then we don’t have to claim it as interest income, but we do have to claim it as capital gains.

Why so confusing? Because taxes, that’s why. So if we’re planning on making an investment career out of market discounts (which is probably not advisable), we should find ourselves a tax accountant who can help us sort through it all and keep us on the right side of the IRS.