A taxpayer purchased a bond for $900 (face value $1,000) in the secondary market. The bond has $100 of market discount. The taxpayer does NOT elect to include market discount in income currently. Two years later, the taxpayer sells the bond for $950. At the time of sale, accrued market discount is $30. What is the character of the $50 gain?

Answer options:

$50 capital gain.

$50 ordinary income.

$30 ordinary income and $20 capital gain.

$20 ordinary income and $30 capital gain.

How to approach this question

Rule: Gain on market discount bond is Ordinary to extent of accrued discount. Remainder is Capital.

Full Answer

C.$30 ordinary income and $20 capital gain.✓ Correct

Under the market discount rules, gain on the disposition of a market discount bond is treated as ordinary income (interest) to the extent of the accrued market discount. Accrued discount = $30. Total Gain = $950 - $900 = $50. Therefore, $30 is ordinary income, and the remaining $20 is capital gain.

Common mistakes

Treating the entire gain as capital.

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