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Now could be a good time to recoup some bond-holding losses

By Robert Edwards / November 4, 1981



If you're sitting with a safe-deposit box full of bonds purchased long ago and now showing a loss - what do you do? You could hang on grimly, but other options could leave more cash in your pocket.

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Reader H. P. H. owns 47 bonds of six different companies with coupon rates ranging from 81/2 to 101/2 percent purchased years ago at or near par. Maturities range from 1986 through 2009. Current market value totals $29,620 for a loss of $17,380.

''Would it be wise to sell these and take a loss, then invest the proceeds to rebuy some deep discount bonds that would yield from 15 to 17 percent or put the cash into money market mutual funds yielding about the same? My tax bracket is about 12-plus percent. Could I use the loss to offset other income?''

A unique opportunity exists for the remainder of this year to take losses and build a lower cost basis for profits in following years.

Bonds are traded today much like stocks, and their prices vary according to general interest rates. Selling one batch of discounted bonds and buying others will not likely match or increase revenue. Assuming the same quality of bonds, a difference between bid and asked prices plus commissions (as much as $30-$45 on each bond) work against the trade.

For example, Reader H. P. H. owns 10 utility bonds, each with a market value of $635 maturing in 2009 paying a coupon rate of interest at 101/2 percent on original value. On the discounted price the $105 annual interest amounts to a current yield of 16.5 percent. Selling such a bond and buying a different one of similar quality would leave you with an asset worth $635, but out-of-pocket about $30, for a net yield of about $605. For a similar $105 current yield, a new bond would need to earn 17.4 percent to break even. Such trades of comparable quality bonds are unlikely on the same day. For a trade to generate the same income, either the risk would be greater - that is, a purchase of lower-rated bonds - or market conditions would need to change.

Tax considerations could make taking the loss this year attractive. Using the same bond figures, instead of $105 in interest, Reader H. P. H. might earn $100. 07 assuming a good trade for a loss in income of $4.95 a year on each bond. His marginal tax bracket (not the average he reports at 12-plus) could be about 24 percent in 1981, about 22 percent in 1982 and 19 percent in 1983. The $1 differential in taxes paid on $100.07 reduces the net loss to about $3.93.

Long-term capital losses could make up the difference. A loss of $380 on each bond ($1,000 original cost less $620) and a marginal tax bracket of 24 percent for 1981 would, on a 2-for-1 basis, offset ordinary income of $190. The tax saving for 1981 at the marginal rate of 24 percent would be about $45.60.

With a cost basis of $605, any sale at a higher price later would generate a long-term capital gain (if held longer than one year). Suppose the bond regained a value of $980, net after commissions, when sold in 1983. The gain of $380 would be taxed at 19 percent of $152 (40 percent of $380) or $28.88. Thus, the difference between $45.66 and $28.88 would represent a tax benefit equal to about four years of lesser net income from the trade.