Smart Bond Investing—Buying and Selling Bonds
As with buying and selling stocks, there are tax consequences associated with buying and selling bonds. Interest Income
Whether or not you will need to pay taxes on a bond's interest income (coupons) or a bond fund's dividends depends on the entity that issued the bond.
Taxes on Bond Interest
The 2003 tax reduction bill, formally known as the Jobs and Growth Tax Relief Reconciliation Act, lowered taxes on stock dividends and long-term capital gains on securities held in taxable accounts to a maximum of 15 percent through the end of 2010. And the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 extended many tax reductions through 2012.
Note: Some bond mutual funds refer to their taxable income distributions as "dividends," but these are not stock dividends, and are not entitled to the lower 15 percent rate.
Be wary of making investment decisions based solely on current tax rates, especially since the lower dividend and long-term capital gains tax rates are scheduled to end or "sunset" after 2012.
When you purchase an individual bond at face value and hold it to maturity, there is no capital gain to be taxed. Of course, if you sell the bond for a profit before it matures, you'll likely generate a taxable gain, even if it's a tax-exempt bond. If you owned the bond for more than a year, your gain is taxed at the long-term capital gain rate, which is currently, at most, 15 percent. If you owned the bond for one year or less, you are taxed at the short-term rate, which can be as high as 35 percent.
With a bond fund, you are unlikely to sell at the exact share price at which you bought, which means you incur a capital gain or loss. In addition, mutual fund managers buy and sell securities all year long, incurring capital gains and losses. If the gains are more than the losses, shareholders will receive a capital gain disbursement at the end of the year.
|Remember: the tax rules that apply to bonds are complicated. Before investing, you may want to check with your tax advisor about the tax consequences of investing in individual bonds or bond funds.|
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