Tax Consequences: Sale of a Bond Example Problem

In 2007, Mr Lewis paid $40,000 for a corporation bond with a $50,000 stated redemption value. Based on the bond's yield to maturity, amortization of the $10,000 discount was $695 in 2007. Mr. Lewis sold the bond for $42,000 in 2008. What are his tax consequences in each of these years, if he bought the bond in the public market through his broker?

a. 2007, $0; 2008, $2,000 capital gain
b. 2007, $0; 2008, $2,000 ordinary income
c. 2007, $695, ordinary income; 2008, $1,305 capital gain
d. 2007, $695, ordinary income; 2008, $1,305 ordinary income

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...ld have been:

Debit: Bond basis $695
Credit: Interest income $695

At of 1-1-08, the basis in the bond is ...