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Municipal Bonds
Market discount bonds and the de minimis exception
A bond is considered to be a market discount bond if it is bought in the secondary market at a price that is below par (or below the adjusted issue price in the case of an original issue discount bond). Market discount bonds produce a yield that is greater than the tax-exempt yield at which the bond was originally issued. The predictable increase in value that occurs as the bond approaches maturity, when it will be worth par, is the accretion of the discount.
Since 1993, taxpayers have been required to treat the interest income attributable to the accretion of market discount as ordinary income, rather than as tax-exempt income or capital gain. Because of the recent rise in interest rates, this tax on the accretion of market discount has become a matter of greater interest in the municipal market and has caused investors to consider whether the amount of the discount is more than a de minimis amount.
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Endnotes
Sources
“Pushing Bonds Over the Edge: Investor Demand and Municipal Bond Liquidity”
John Bagley, Stefan Gissler, Kent Hiteshew, & Ivan T. Ivanov
https://www.brookings.edu/wp-content/uploads/2023/05/muni_liquidity_july_updated.pdf “
Tax and Liquidity Considerations for Buying Discount Bonds”
https://www.msrb.org/sites/default/files/Tax-and-Liquidity-Considerations-for-Buying-Discount-Bonds.pdf
A convenient source for information on the tax treatment of market discount municipal bonds is Publication 550 by the Internal Revenue Service https://www.irs.gov/pub/irs-pdf/p550.pdf
The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Performance data shown represents past performance and does not predict or guarantee future results. Investing involves risk; principal loss is possible.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such. For term definitions and index descriptions, please access the glossary on nuveen.com. Please note, it is not possible to invest directly in an index.
Important information on risk
Investing involves risk; principal loss is possible. All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Investing in municipal bonds involves risks such as interest rate risk, credit risk and market risk. The value of the portfolio will fluctuate based on the value of the underlying securities. There are special risks associated with investments in high yield bonds, hedging activities and the potential use of leverage. Portfolios that include lower rated municipal bonds, commonly referred to as “high yield” or “junk” bonds, which are considered to be speculative, the credit and investment risk is heightened for the portfolio. Bond insurance guarantees only the payment of principal and interest on the bond when due, and not the value of the bonds themselves, which will fluctuate with the bond market and the financial success of the issuer and the insurer. No representation is made as to an insurer’s ability to meet their commitments.
This information should not replace an investor’s consultation with a financial professional regarding their tax situation. Nuveen is not a tax advisor. Investors should contact a tax professional regarding the appropriateness of tax-exempt investments in their portfolio. If sold prior to maturity, municipal securities are subject to gain/losses based on the level of interest rates, market conditions and the credit quality of the issuer. Income may be subject to the alternative minimum tax (AMT) and/or state and local taxes, based on the state of residence. Income from municipal bonds held by a portfolio could be declared taxable because of unfavorable changes in tax laws, adverse interpretations by the Internal Revenue Service or state tax authorities, or noncompliant conduct of a bond issuer. It is important to review your investment objectives, risk tolerance and liquidity needs before choosing an investment style or manager.
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