Some bonds have provisions that let companies redeem them early. Find out the tax consequences.
Bonds don't get as much attention in the investing world as stocks do, but they play an equally important function in investment portfolios. The predictable cash flows that bonds offer stand in stark contrast to the uncertain returns of stocks. Bonds have fixed dates on which the issuer can pay back the principal amount it owes, and when that happens, bondholders have to be prepared for the tax consequences. Below, we'll look more closely at how bond redemptions get taxed and how to calculate gain or loss.
Two kinds of bond redemptions
Bonds get paid back in two different ways. The most common is when a bond matures naturally. Every bond has a specified maturity date on which the bond issuer must repay the face value of the bond. On the date, bondholders have their bonds redeemed and receive a final cash payment.
The other type of bond redemption occurs before the stated maturity date. Some bonds have specific call provisions that allow the issuer to redeem the bond at specified dates prior to maturity at a stated price, which can be the same as or different from the bond's face value. In addition, companies sometimes do tender offers to buy back bonds on the open market, and when that happens, selling bondholders have their bonds redeemed in exchange for the agreed-upon payment.
Calculating gain or loss
In many cases, calculating the gain or loss on a bond redemption is fairly simple. If you take the redemption proceeds and subtract what you originally paid for the bond, then the difference will tell you the answer. If it's positive, then you have a gain. If it's negative, you've lost money on the bond.
Complicating the issue is that in some cases, your tax basis will be different from what you paid for the bond. For example, in bonds with what's known as original issue discount, the bondholder must claim a portion of the discount as taxable income each year. That income increases the tax basis in the bond, reducing the eventual gain upon redemption. In general, though, taking what you got in the redemption transaction and subtracting cost basis will give you your gain or loss.
Most bond investors choose their specific investments with the primary focus on finding ways to provide the regular income over the course of the bond's lifetime prior to maturity. Yet as important as interest income is, you also have to be prepared for what happens when the issuer redeems the bond. Otherwise, the tax consequences could take you by surprise.
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FAQs
In many cases, calculating the gain or loss on a bond redemption is fairly simple. If you take the redemption proceeds and subtract what you originally paid for the bond, then the difference will tell you the answer. If it's positive, then you have a gain. If it's negative, you've lost money on the bond.
How to calculate gain or loss on bond refunding? ›
Economic gain or loss is the difference between the present value of the old debt service requirements and the present value of the new debt service requirements, discounted at the effective interest rate and adjusted for additional cash paid. 117.
How do you calculate capital gain or loss on a bond? ›
Capital gains yield is calculated the same way for a bond as it is for a stock: the increase in the price of the bond divided by the original price of the bond. For instance, if a bond is purchased for $100 (or par) and later rises to $120, the capital gains yield on the bond is 20%.
How do you calculate the gain or loss on the retirement of the bonds payable? ›
The amount of the gain is computed by subtracting the amount spent to repurchase the bonds from the bonds' carrying value.
What is the formula for gain or loss? ›
Take the selling price and subtract the initial purchase price. The result is the gain or loss.
How to calculate gain on a bond? ›
The chargeable gain is calculated in the same way as a full surrender with the proceeds being the higher of the bond cash-in value at the maturity date or the guaranteed maturity value.
How to calculate bond redemption? ›
The redemption value is stated as a percentage of face value. For example, a $1000 bond redeemable at 105 is redeemed at 105% of $1000 = $1050.
How do you calculate realized gain on a bond? ›
To calculate a realized gain or loss, take the difference of the total consideration given and subtract the cost basis. If the difference is positive, it is a realized gain. If the difference is negative, it is a realized loss.
Is there always a gain or loss when bonds are redeemed? ›
The redemption of bonds can be done at three value and in each case there can be loss, gain or neutral situations. The possible redemption values are: Redemption value and carrying value (face value) are equal, here there is no gain or loss on redemption.
How to find bond redemption? ›
For redemption or other information about U.S. savings bonds, visit the U.S. Treasury Department's web page, www.treasurydirect.gov, or contact their office directly by calling (844) 284-2676 (toll-free).
If you buy a bond when it is issued and hold it until maturity, you generally won't have a capital gain or loss. However, if you sell the bond before its maturity date for more than you paid for it, you'll typically have a capital gain. If you sell it for less than you paid for it, you'll usually have a capital loss.
How do you calculate gain or loss on redemption? ›
In many cases, calculating the gain or loss on a bond redemption is fairly simple. If you take the redemption proceeds and subtract what you originally paid for the bond, then the difference will tell you the answer. If it's positive, then you have a gain. If it's negative, you've lost money on the bond.
What is the formula for gain or loss on retirement? ›
The retirement process calculates gain and loss using this formula: Gain or Loss on Retirement = Asset Cost - Proceeds of Sale - Cost of Removal - Net Book Value Retired + Revaluation Reserve Retired.
How do you calculate unrealized gain or loss on a bond? ›
In order to calculate unrealized gains and losses, subtract the asset's value at the time it was purchased from its current market value. If the resulting amount is positive, the asset has gained in value, and there are unrealized gains.
How do bonds gain and lose value? ›
What causes bond prices to fall? Bond prices move in inverse fashion to interest rates, reflecting an important bond investing consideration known as interest rate risk. If bond yields decline, the value of bonds already on the market move higher. If bond yields rise, existing bonds lose value.
How do you account for bond redemption? ›
When a company redeems bonds, the accounting will typically involve: Removing the Bonds Payable Liability: The face value of the bonds is removed from the liability section of the balance sheet. Paying Cash : The company reduces its cash balance by the amount paid to redeem the bonds.
