7632 / How are the proceeds taxed on the sale or redemption of Treasury notes and bonds?
(1) If the sale occurs between interest dates, as it generally does, the seller usually receives from the buyer an amount stated separately from the purchase price representing stated interest accrued to the date of sale, but not yet due. This is reported by the seller as interest income, not gain.1
(2) Out of the proceeds (other than interest, discussed above) an amount equal to the taxpayer’s adjusted basis in the note or bond and expenses of sale is recovered tax-free.2 The taxpayer’s basis is generally the cost of acquisition adjusted by (i) adding any original issue discount (OID) and market discount included in income as it accrued,3 or (ii) subtracting the amount of premium deductible or applied to reduce interest payments over the period the taxpayer held the bond if he or she elected to amortize the premium (see Q 7644, Q 7650, Q 7654).4
(3) As a general rule, amounts in excess of (1) and (2) are treated as capital gain (long-term or short-term, depending on the holding period and the date of acquisition). See Q 699 and Q 702 for more information on the calculation of holding periods and the treatment of capital gains and losses. However, in the following special circumstances part or all of the gain must be treated as ordinary income: