Author Topic: bond premium rules for folio purchases and taxes  (Read 3466 times)

lender_john

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bond premium rules for folio purchases and taxes
« on: March 04, 2013, 12:28:50 PM »

This was briefly touched on in one of the posts earlier, but it wasn't particularly clear what is the best way to approach it, if at all.

The basic idea is that many people in 'foliofn only states' buy notes at a slight premium.  In theory that should.. or could be deductible over the life of the note.  While its a small amount on each note, it could add up for those that buy 1000s of notes each year.

Has anyone actually kept track of this, or filed their taxes with it?
Does it really apply to lending notes and do you could the principal as the basis or the principal plus interest?

I know this really gets into the weeds on taxes.. but we all make money from this... and no one wants to pay more taxes than they have to.

What makes this particularly interesting/relevant is that bond premium is one of those investment deductions that isn't subject to the 2%, as far as I know..

AmCap

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Re: bond premium rules for folio purchases and taxes
« Reply #1 on: March 04, 2013, 09:36:26 PM »

This was briefly touched on in one of the posts earlier, but it wasn't particularly clear what is the best way to approach it, if at all.

The basic idea is that many people in 'foliofn only states' buy notes at a slight premium.  In theory that should.. or could be deductible over the life of the note.  While its a small amount on each note, it could add up for those that buy 1000s of notes each year.

Has anyone actually kept track of this, or filed their taxes with it?
Does it really apply to lending notes and do you could the principal as the basis or the principal plus interest?

I know this really gets into the weeds on taxes.. but we all make money from this... and no one wants to pay more taxes than they have to.

What makes this particularly interesting/relevant is that bond premium is one of those investment deductions that isn't subject to the 2%, as far as I know..

That's generally correct, but there's a twist that I'm not sure about.

Purchasers of taxable bonds bought at a premium include that premium in their basis in the note, and may elect to amortize the bond premium over the life of the loan according to the constant yield method.  The amortized bond premium then offsets the qualified stated interest you include on the note, so it's not really a deduction in that sense.  But I don't think LC notes have qualified stated interest, which is what gives rise to the OID issue that's been discussed.  So the bond premium is subject to the excess premium rules, which permit a deduction to the extent that there has been any includible interest in excess of the bond premium deductions claimed in previous accrual periods.  You correctly note that the deduction is not subject to the 2% floor.

The one issue that sticks out to me is how the code and regs define "premium."  A bond should have premium for tax purposes if the holder's basis immediately after purchase of the note is greater than the stated redemption price at maturity (SPRM).  Readers who remember the conversation about OID will know that SPRM is equal to the sum of all payments of principal and interest due under the note, except for qualified stated interest.  We believe that LC takes the position that notes have no qualified stated interest, which is what gives rise to OID.

So, if all of the interest that's due under the note is included in SPRM, then the note would not be issued at premium for tax purposes unless the premium was greater than the sum of all of the interest due on the note.  A buyer would have to buy a note at extreme premium in order to establish a basis that would exceed the SPRM on a note with no QSI.

If the bond premium isn't amortized (either because you didn't elect to, or because the note doesn't have premium), then the premium is just included in your basis, and you would recognize a capital loss when the note matured (or a reduction of your gain if you decided to re-sell the note).

AmCap

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Re: bond premium rules for folio purchases and taxes
« Reply #2 on: March 04, 2013, 09:46:34 PM »
From the prospectus:

Quote
If a U.S. Holder purchases a Note on the trading platform for an amount greater than the Note’s adjusted issue price but less than the sum of all amounts payable on the Note after the purchase date, the Note will be treated as acquired at an acquisition premium.

For a Note acquired with an acquisition premium, the amount of OID that the U.S. Holder must include in gross income with respect to the Note for any taxable year will be reduced by the portion of the acquisition premium properly allocable to such taxable year.  If a U.S. Holder purchases a Note on the trading platform for an amount in excess of the sum of all amounts payable on the Note after the purchase date, the U.S. holder will not be required to include OID in income with respect to the Note.

So I'm differing from prospectus a bit, just for the sake of disclosure.  The first paragraph doesn't quite track w/ the language of the statute and regs, which say to look at the holder's basis to see if it is greater than the SPRM.  On the second paragraph, I'm think that's wrong - I think you can only use bond premium to shelter included qualified stated interest.  But to be honest, I'm not sure.  I might need a day to think on it.

In the meantime, I'd say def. track the premium you pay on folio for your records. 




brycemason

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Re: bond premium rules for folio purchases and taxes
« Reply #3 on: March 05, 2013, 01:03:55 PM »
Your tax knowledge is impressive! Thank you for making this contribution.

lender_john

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Re: bond premium rules for folio purchases and taxes
« Reply #4 on: March 05, 2013, 03:16:12 PM »

Thanks for the detailed reply.  This is very helpful and definitely clears up a fairly complicated matter.

I thought it would also be a valid option to count the basis just on the principal.  Since its possible that the note can be paid off at anytime based on the principal. So its possible to pay the principal and one month's interest for the note and LC wouldn't count it as a markup and only receive the principal if the borrower pays off the note immediately.

I probably wouldn't want to go against the prospectus on this and risk filing incorrectly, although I believe a number of others have mentioned that the "adjusted price" isn't quite correct.