How does one account for the 'premium" or 'discount' on a treasury note held to maturity for tax purposes?

Question

Try this:
Assume you bought a Treasury Note maturing in 6 months for $24800 (face value=25,000) and held it untill it matured. Do you account for the $200 as a short term capital gain (where it seems to be reported on the 1099) or as treasury interest? Is it still taxable as a gain by my state (CA)?

Answer 1

The discount is taxed as ordinary income on line 21 of your 1040. This income increases you cost basis to face value so you have no short term gain - but you still report it on Schedule D with no gain. This is taxable on your state return since the income is not a US Treasury obligation - the discount is a bond market discount under IRC Section 1276. See IRS publication on investment income.

Answer 2

Based on my fading memory of accounting class and my reading of IRS Publication 550, I believe the premium or discount is used to adjust the amount of interest recognized.