Buying and Selling Bonds

Bonds are bought and sold in huge quantities in the U.S. and around the world. Some bonds are easier to buy and sell than others—but that doesn't stop investors from buying and selling all kinds of bonds virtually every second of every trading day.

The way you buy and sell bonds often depends on the type bond you select.

  • Treasury and savings bonds may be bought and sold through an account at a brokerage firm, or by dealing directly with the U.S. government. New issues of Treasury bills, notes and bonds—including TIPS—can be bought through a brokerage firm, or directly from the government through auctions at the U.S. Treasury Department's TreasuryDirect website.
  • Savings bonds can also be purchased from the government, or through banks, brokerages and many workplace payroll deduction programs.
  • Corporate and municipal bonds may be purchased, like stock, through through full-service, discount or online brokers, as well as through investment and commercial banks. Once new-issue bonds have been priced and sold, they begin trading on the secondary market, where buying and selling is also handled by a broker. You will generally pay brokerage fees when buying or selling corporates and munis through a brokerage firm.

Buying anything but Treasuries and savings bonds typically requires using a broker. You can buy virtually any type of bond or bond fund through a brokerage firm. Some firms specialize in buying and selling a specific type of bond, such as municipal bonds

In bond transactions, your firm can act as an "agent" or "principal."  If the firm acts as agent in a bond transaction with you where you want to buy a bond—it seeks out bonds from sellers for you. If you are selling, the firm will search the market for potential buyers. When the firm acts as principal, which is the case for most bond transactions, it sells you a bond that the firm already owns, sometimes referred to as selling the bond from inventory, or buys the bond from you for its own inventory. When the firm is acting as principal, the broker's compensation typically is in the form of a mark-up or mark-down. 

The firm's mark-up or mark-down is included in the price you pay for the bond. You will want to pay close attention to the costs, fees and broker compensation you are charged in any bond transaction. 

Taxes

As with buying and selling stocks, there are tax consequences associated with buying and selling bonds because of the income or gains you accrue with your bond investments.

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.

  • Corporate and Mortgaged-Backed Bonds—The interest you get from corporate and mortgage backed bonds typically is subject to federal and state income tax.
  • Treasuries and Other Federal Government Bonds—The interest you earn on Treasuries and agency bonds backed by the "full faith and credit" of the U.S. government is subject to federal income tax, but not state income tax. This does not include bonds in which the U.S. government only provides a guarantee such as with Ginnie Maes.
  • Municipal Bonds—Municipal bonds are generally exempt from federal income tax. If the municipal bond was issued by your state or local government, the interest on the bond is usually exempt from state and local taxes, as well. However, if the bond was issued by a state or local government outside of the state in which you reside, the interest from the bond is usually subject to state income tax. Bonds issued by a U.S. Territory, such as Puerto Rico or Guam, however, are exempt from federal, state and local taxes in all 50 states.

As of January 1, 2013, the tax code imposes a Net Investment Income Tax of 3.8 percent on investors who meet certain income thresholds and other criteria. To learn more about the tax, who it applies to and how you calculate net investment income, be sure to talk with your tax professional or read the IRS's Net Investment Income Tax FAQs.

Capital Gains

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. If you owned the bond for one year or less, you are taxed at the short-term rate.

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. For additional information on the tax treatment of investment income, see IRS Publication 550 as well as the IRS's Net Investment Income Tax FAQs.