Secondary Brokered CDs And Taxes

John19 | Oct 24, 2022 | 395 posts since 2022

Is it better/worse to buy a secondary CD with a low coupon to avoid paying higher yearly taxes than you would on a new issue? You have to pay capital gains on the price difference?

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NFO | Oct 25, 2022 | 66 posts since 2022

A gain on a bond/brokered CD purchased below par would be realized when it was either sold, presumably at a profit, or when it matures. Yes, you would owe a tax on the gain. Yes, a bond or CD yielding a lower coupon rate would result in less interest and, consequently, less annual tax liability. Ultimately, the total tax liability is a complex question with several variables. I guess your need for the annual income largely determines whether it's potentially "better/worse".

John19 | Oct 25, 2022 | 395 posts since 2022

Yeah, I was thinking it might be taxed less at 0% or 15% capital gains, but there is probably something stupid I'm not thinking of yet.

MAKNYC | Oct 25, 2022 | 323 posts since 2015

One minor point that you would need to confirm with an expert as I am confident, but not certain…

You used the term ‘capital gain’. I believe in the fact pattern you describe that the gain would be considered ordinary income, and not subject to the preferential capital gain treatment. If true, higher marginal rate applied (same as the coupon) and no ability to offset the price accretion by netting with capital losses.

John19 | Oct 25, 2022 | 395 posts since 2022

So if I bought a secondary treasury with a 0.5% coupon and yield of 4.34%, the price is 82.686. So I pay ordinary income tax on the difference of 100 to 82.686 when it matures? Or another type of tax? Keep in mind that i'm a moron, thanks.

MAKNYC | Oct 25, 2022 | 323 posts since 2015

Just like in your original question with the CD, so long as we are discussing purchasing in the secondary market at a discount, the same ordinary tax treatment should apply. If you hold the bond/CD till it’s stated maturity, the accretion would be ordinary income. If however you sold the bond/CD prior to maturity, the portion of the gain or loss that differed from the accreted value at that point in time would be considered capital gain/loss, but would not likely be significant.

So for your question….yes, the 17+ point gain would be taxed as ordinary income in the year of maturity (unless you decided to significantly complicate your life and taxes by declaring the accreted gains on an annual basis). Another minor caveat is if the bond is an.original issue discount (OID) bond, but let’s not go there. Even if it is it won’t have much impact on the taxation timing/consequences.

Again, I am confident, but not certain.

P.S. interesting dynamics right now in the municipal bond market related to these rules. Since we have been near 0% for so long, most munis still outstanding have 3Ish % coupons, hence they are trading at huge discounts to par (70’s). Long term AAA/AA+ can be had for 5.3% YTM right now. But new issues and /or higher coupon bonds trade at considerably lower yields. Reason is this treatment….on the discount muni that accreted discount will be taxable as ordinary income upon maturity so only the coupons will be free of tax. Higher tax bracket investors don’t want these bonds because of this treatment hence creating a dislocation in the market and an opportunity for people in lower tax brackets.

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