A taxpayer purchased a bond for $900 (Face Value $1,000) on the secondary market. The bond has 5 years to maturity. The taxpayer elects to amortize the market discount. How is the amortization treated?

Answer options:

It is treated as interest income annually and increases the bond's basis.

It is treated as capital gain at maturity.

It is not taxable until the bond is sold.

It is deductible as an expense.

How to approach this question

Market Discount = Interest Income. If you elect to amortize it, you pay tax on it each year (as interest) and bump up your basis so you don't get taxed again at the end.

Full Answer

A.It is treated as interest income annually and increases the bond's basis.✓ Correct

Market discount is generally treated as ordinary interest income. If the taxpayer elects to include it currently, they report interest income annually and increase the basis of the bond. If not, the accrued discount is reported as ordinary income upon sale/maturity.

Common mistakes

Thinking market discount generates capital gain.

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