7652. How are buyer and seller taxed on a bond bought or sold “flat”?Nuco Employeercline202014-10-01T14:12:00Z2014-10-01T14:12:00Z34462548Summit Business Media215298914Site Map/Investments/Bonds/Bonds Traded _quote_Flat_quote_TaxFactsDefaultArticle2007-01-30T00:00:00Z121641133-00-tf2.xml1133.00;#1845;#0x010100C568DB52D9D0A14D9B2FDCC96666E9F2007948130EC3DB064584E219954237AF3900242457EFB8B24247815D688C526CD44D009C4E67E972694125ABDA91AC61F5E51FTax Facts 2How are buyer and seller taxed on a bond bought or sold “flat”?51800.0000000000TaxFactsDefaultArticle2010-01-14T23:09:49ZSBMEDIA\moss-admin7652. How are the buyer and seller taxed on a bond bought or sold “flat”?Bonds on which interest or principal payments are in default may be quoted “flat,” that is, without any allocation in the quoted price between accrued but unpaid interest and principal.The purchaser of a bond quoted flat treats any payment received attributable to interest that accrued before the purchase of the bond as a return of capital that reduces basis. Amounts received in excess of the tax basis in the bond are capital gain.Rickaby v. Comm., 27 TC 886 (1957), acq. 1960-2 CB 6; Rev. Rul. 60-284, 1960-2 CB 464. They are not treated as interest.First Ky. Co. v. Gray, 190 F. Supp. 824 (W.D. Ky. 1960), aff’d, 309 F.2d 845 (6th Cir. 1962). Thus, if the bond is a tax-exempt municipal bond, return of interest accrued prior to acquisition reduces the owner’s basis, and any excess is taxable as capital gain, not tax-free interest.R.O. Holton & Co. v. Comm., 44 BTA 202 (1941); Noll v. Comm., 43 BTA 496 (1941).The owner of a bond, whether or not purchased flat, treats any payment of interest attributable to defaulted interest that accrued after the purchase of the bond as interest when it is received. It does not make any difference whether the amounts are received from the obligor or from a purchaser, or whether or not the obligation is held to maturity.Fisher v. Comm., 209 F.2d 513 (6th Cir. 1954), cert. den., 374 U.S. 1014; Jaglom v. Comm., 36 TC 126 (1961), aff’d, 303 F.2d 847 (2d. Cir. 1961); Tobey v. Comm., 26 TC 610 (1956), acq. 1956-2 CB 8; Shattuck v. Comm., 25 TC 416 (1955); First Ky. Co. v. Gray, above; Rev. Rul. 60-284, above.Thus, where the face amount and all interest accrued before and after purchase is paid in full on redemption of the bonds by the obligor, the amount of interest accrued after purchase is interest and the balance of the proceeds is return of capital, which is tax-free to the extent of the purchaser’s basis, and capital gain to the extent it exceeds basis.Tobey v. Comm., above. See Q 530 for the treatment of capital gains and losses.But where the amount received on a flat sale or on redemption is less than the entire amount due (principal and interest), the amount recovered is allocated between principal and interest accruing while the seller held the bond under the following formula:Jaglom v. Comm., above. See also First Ky. Co. v. Gray, above, and Shattuck v. Comm., above.purchase price allocableto interest accrued whileSeller owned bond=face amount of interestaccrued while Sellerowned bondamount received on saleface amount of principaland interest due at saleHowever, the appeals court in Jaglom suggested (but did not decide because the question was not appealed) that where a sale occurred in anticipation of imminent payment by the debtor, the fair market value of principal and interest would be more appropriately used in the formula than face value.If a bond was held as part of a tax straddle, the additional rules and qualifications explained in Q 7586 to Q 7602 apply. If a bond was held as part of a conversion transaction, the rules as explained in Q 7603 and Q 7604 will apply.