Municipal Bond Capital Gains and Losses
Even though the interest paid on municipal
bonds is tax exempt, a holder can recognize capital gains or
capital losses that are subject to federal income tax on
the sale of such municipal bonds, just as in the case of a
How to calculate municipal bond capital
gains or losses?
The amount of capital gains or capital
losses are equal to the difference between:
the sale price of the municipal bond and
the holder's tax basis in the municipal bond (the
amount the holder paid for the bond originally,
including any additions to such basis, such as
or OID as discussed in the
Thus, if a municipal bonds holder
purchased a $5,000 face amount municipal bond for $5,000 and
then sold the municipal bond for $5,200, the holder would have
a capital gains of $200.
Typically, the purchase and sale price of a
municipal bond includes the dealer's markup; however in cases
where a commission is charged, it should be taken into account
by the holder in computing gain or loss.
Types of Capital Gains: Long term capital
gains and short term capital gains
There are currently two types of capital
gains: long term capital gains and short term capital gains.
Long term capital gains require that the
municipal bonds be held for more than 12 months
before they are sold; short term capital
gains are the result of holding a bond for 12 months or
The maximum tax rate on long term capital
gains is lower than the maximum tax rate on
short-term capital gains which is usually also the maximum
tax rate on ordinary income. Furthermore, the maximum tax
rate on long term capital gains is reduced in some cases when
the investor has held it for a number of years.
Capital losses on municipal bonds
When municipal bonds are sold, an
investor may also recognize capital losses if the sale proceeds
(adjusted for selling costs) are less than the municipal
bonds holder's tax basis. In such a case, capital losses
are first applied against capital gains of the same type to
reduce such gains. Thus, a long term capital loss will first
reduce long term capital gains, and a short term capital loss
will first reduce short term capital gains. Any excess long
term capital loss is used to offset short term capital gains.
Any excess short term capital loss is used to offset long term
capital gains. Any capital losses remaining after offsetting
all available capital gains can then be used to reduce ordinary
income by up to $3,000 per year, with any losses in excess of
that amount available to be carried forward indefinitely to
reduce capital gains or ordinary income in future years under
the same procedures.