Statement of meaning of ‘Market Discount’
The market discount is the difference between a bond’s held redemption price and its purchase price on the secondary market, if it has been obtained at a price below par. Market discount arises when a bond’s value on the unoriginal market decreases after it has been issued, usually because of an expand in interest rates. In the case of original issue discount (OID) securities such as zero-coupon connections, the market discount is the difference between the purchase price and the issue sacrifice plus accrued OID.
BREAKING DOWN ‘Market Discount’
Market mark down on a bond is not subject to taxation annually in the U.S., but it is taxable as ordinary interest proceeds in the year that the bond is sold or redeemed. The bond investor can also first-rate to include amortized market discount annually in income for tax purposes, although this wish mean paying tax on it now rather than in the future. Note that shop discount is taxable even if regular interest income from the thongs in question is tax-exempt like it is for municipal securities.
For example, assume that a U.S. investor profits $900 for a bond that was originally issued with a par value of $1,000. The $100 metamorphosis between the par value and the purchase price is the market discount. This leftovers will have to be reported as ordinary interest income on the investor’s tax arrival either upon disposition or annually on an amortized basis, depending on the designation made by the investor.
There are certain exceptions to the election rules, such as for U.S. savings agreements and for short-term obligations that mature in one year or less from the appointment of issue. Also, for tax-exempt bonds purchased before May 1, 1993, a profit arising from a market discount is treated as a capital gain more than interest income.
Another exemption to the election of how market reduce should be treated for tax purposes relates to “de minimis” or small market deducts. Under the “de minimis” rule, the market discount is treated as zero if the amount of the mark down upon purchase is less than 0.25% of the bond’s face value, multiplied by the platoon of full years from the time of purchase to the maturity date. If the vend discount is less than the de minimis amount, the market discount wish have to be treated as a capital gain – rather than ordinary takings – when the bond is sold or redeemed.
As an example, if you buy a $1,000 par value handcuffs maturing in 10 years for $985, the market discount is $1,000 – $985 = $15. Since this mark-down is less than the de minimis threshold of $25 (0.25% of $1,000 x 10 = $25), the retail discount is considered to be zero. As a result, the $15 discount will be treated as a cash gain when you sell or redeem the bond.