You’re Kidding Me!
How would you like to limit your capital gains, and therefore limit your capital gains tax, as well as increase the basis of your bonds, which also decreases your capital gains tax?
Did You Know?
When bonds are sold between interest payment dates, part of the cash you receive includes the interest that accrued up until the date of sale. In essence, the cash from your sold investment contains three elements:
- The principal
- Capital gains on the principal, if any
- Interest earned
Here’s How You Do It
If You Are the Seller:
Have your accountant report your accrued interest as gross income. By doing this, you are removing the interest earned as only being capital gains. At the same time, you are increasing the bond’s basis which raises the floor on the bond, also limiting capital gains tax.
Here’s how it looks in an example:
A bond costing $5,000 is sold for $5,300 on May 31. The sale price includes $200 of interest the bond accrued from January 1 through May 31.
Normally the $300 of increased value would be accounted as capital gains, but not this time. Have your accountant report interest income of $200, and capital gains income of $100. By dividing the earned interest and allocating the two portions as shown, you have limited your capital gains income and lowered your capital gains tax accordingly.
If You Are the Purchaser:
As the purchaser, you can deduct the accrued interest from the next interest payment. Use Schedule B to report the total interest payment, and on a separate line list “Accrued Interest”. You can now subtract this amount from the total interest, limiting your tax obligation. By parsing these funds, the basis of the bond does not include the amount of accrued interest.
Here’s a good example of how this works:
The purchaser of the $5,300 bond mentioned above receives $450 in total interest for the year, from June through December. The purchaser’s accountant uses Schedule B to report $250 of taxable interest income ($450 total interest – $200 accrued interest). This reduces the purchaser’s capital gains, siphoning off $200 into the taxable interest income category.
The other advantage is that the bond’s basis remains at $5,100 (the $5,300 purchase price minus the $200 accrued interest), also limiting capital gains taxes.
Summary:
Limiting the amount of taxes you pay can significantly add to your wealth appreciation, your family’s financial well-being, and an ever-improving lifestyle. Consulting with a Certified Financial Planner® (CFP®), providing you with quality financial information and advice, can be very rewarding.
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