Please ensure Javascript is enabled for purposes of website accessibility

How to Calculate Gain or Loss on a Bond Redemption

By Motley Fool Staff – Updated Oct 17, 2016 at 2:26PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Some bonds have provisions that let companies redeem them early. Find out the tax consequences.

Bonds don't get as much attention in the investing world as stocks do, but they play an equally important function in investment portfolios. The predictable cash flows that bonds offer stand in stark contrast to the uncertain returns of stocks. Bonds have fixed dates on which the issuer can pay back the principal amount it owes, and when that happens, bondholders have to be prepared for the tax consequences. Below, we'll look more closely at how bond redemptions get taxed and how to calculate gain or loss.

Two kinds of bond redemptions
Bonds get paid back in two different ways. The most common is when a bond matures naturally. Every bond has a specified maturity date on which the bond issuer must repay the face value of the bond. On the date, bondholders have their bonds redeemed and receive a final cash payment.

The other type of bond redemption occurs before the stated maturity date. Some bonds have specific call provisions that allow the issuer to redeem the bond at specified dates prior to maturity at a stated price, which can be the same as or different from the bond's face value. In addition, companies sometimes do tender offers to buy back bonds on the open market, and when that happens, selling bondholders have their bonds redeemed in exchange for the agreed-upon payment.

Calculating gain or loss
In many cases, calculating the gain or loss on a bond redemption is fairly simple. If you take the redemption proceeds and subtract what you originally paid for the bond, then the difference will tell you the answer. If it's positive, then you have a gain. If it's negative, you've lost money on the bond.

Complicating the issue is that in some cases, your tax basis will be different from what you paid for the bond. For example, in bonds with what's known as original issue discount, the bondholder must claim a portion of the discount as taxable income each year. That income increases the tax basis in the bond, reducing the eventual gain upon redemption. In general, though, taking what you got in the redemption transaction and subtracting cost basis will give you your gain or loss.

Most bond investors choose their specific investments with the primary focus on finding ways to provide the regular income over the course of the bond's lifetime prior to maturity. Yet as important as interest income is, you also have to be prepared for what happens when the issuer redeems the bond. Otherwise, the tax consequences could take you by surprise.

Ready to put your investing dollars to work for you? Head to The Motley Fool's Broker Center and get started today.

This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors. We'd love to hear your questions, thoughts, and opinions on the Knowledge Center in general or this page in particular. Your input will help us help the world invest, better! Email us at [email protected]. Thanks -- and Fool on!

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Nearly 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

HOW THE MOTLEY FOOL CAN HELP YOU

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
376%
 
S&P 500 Returns
119%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 12/02/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.