I am new to investing directly in Treasury securities. I live in a state which assesses income taxes with marginal rate of 7%.
I have this year bought a few 3-6 month zero-coupon T Bills at a discount to maturity amount. In the past I invested via Treasury money funds like SNSXX. I decided to buy T-bills to avoid the 34 bp expense of SNSXX.
I understand that the Original Issue Discount that I bought the T-bill for, i.e. the difference between maturity amount and the discounted purchase amount is taxed as ordinary income for Federal income taxes. This OID amount is exempt from state IT.
However, if I sell the security before maturity is the gain reported as OID or capital gain? And if it is reported as capital gain, will it still be exempt from state taxes? My state treats capital gains as ordinary income and charges the same rate on both.
Probably some of both, unless you sell for exactly the discounted value of the bond as of the day you sell. So first, you need to calculate the discounted value of the bond as of the date that you sell it. Any accrued discount is counted as OID. Any gain or loss from the discounted value is accounted for as a capital gain or a capital loss.
For instance, say you bought a bond with a redemption value of $1000 for $910 that matures in 90 days, so $1 of OID accrues per day. (Yes, I know that’s unrealistic, but these numbers were chosen for ease of math in the example). You sell on day 25, so the discounted value of the bond is $935 ($910 plus the $25 accrued OID).
If you sell for $950, you have $25 in OID and $15 in capital gains.
If you sell for $930, you have $25 in OD and $5 in capital losses.
You would need to dig into the specifics of your state law to confirm, but I would assume that the OID would be exempt. Capital gains/losses exemption on Treasuries varies by state.
I buy T-bills on a regular basis, both via TreasuryDirect and via brokerage accounts. I just looked at my TD 1099 form and they call all the interest on T-bills “interest”, not “OID”. The total is aggregated over all my T-bills and is in 1099/box 3, “Interest On U.S. Savings Bonds And Treas Obligations”. Box 8, “OID” is zero. My brokers also report it as interest, not OID.
I always hold my T-bills through maturity, but for fun I periodically check a current value or two, and with the bid/ask spreads it has NEVER been worth selling before maturity. The only thing I can think of that would induce someone to sell is if they need the money immediately. I think the value at sale minus the basis would still be considered to be “interest” rather than “capital gain” or “OID”.
Now, this is NOT true for Treasury notes or Treasury bonds. They are sold at face minus an OID (if any), and pay interest twice a year (usually). Upon sale, the sale price minus the basis would be a capital gain (short or long depending on holding period).
And TIPS are way more complicated. But have similar treatment to notes and bonds.