What’s Your Cost Basis on a Bond Bought at a Discount? (w/Examples) + FAQs

This article reflects federal rules as of June 2026 and covers tax year 2025 (the 2026 filing season). Tax law changes — confirm current figures before you file.

Quick Answer

Your cost basis is what you paid for the bond, then adjusted up over time. For tax year 2025, you raise basis by any original issue discount (OID) you reported as income each year. For market discount, basis only rises if you elected to accrue it; otherwise basis stays at your purchase price and the discount becomes ordinary income at sale.

A bond bought below face value looks simple, but the tax rules behind your cost basis are not. The number your broker prints in Box 1e of Form 1099-B may not match the basis the IRS actually expects you to use, and that mismatch is what triggers a higher tax bill, an underpayment notice, or a refund you never claim.

The stakes are real because the discount on your bond is usually taxed as ordinary income — at rates up to 37% for tax year 2025 — not at the gentler long-term capital gains rates of 0%, 15%, or 20%. The U.S. bond market topped over $58 trillion in outstanding debt by 2025 according to SIFMA, and millions of those bonds change hands below face value every year, so getting your basis right is not a niche problem.

Here is what you will learn:

🧮 How to calculate your true cost basis for OID bonds, market discount bonds, and de minimis discount bonds
📉 Why a discount taxed as ordinary income costs you more than a capital gain — and how to soften the hit
📝 How to report your basis correctly on Form 8949, Schedule D, and Schedule B without overpaying
⚠️ The seven costliest mistakes that turn a clean sale into an IRS notice
🏛️ How tax-exempt municipal bonds change the math when they are bought at a discount

What “Cost Basis” Means for a Discount Bond

Cost basis is the dollar figure the IRS uses to measure your gain or loss when you sell, redeem, or otherwise dispose of a bond. You subtract your basis from your sale proceeds, and the difference is your taxable gain or deductible loss. Get the basis too low and you overpay tax; get it too high and you risk an IRS adjustment.

For a bond bought at a discount, basis is never a fixed number — it can move every year you hold the bond. Your starting basis is generally your purchase price plus any commission or fee you paid. From there, the rules differ sharply depending on why the bond was cheap, and that single distinction drives the entire rest of this article.

The reason a bond sells below its face value (also called par or the stated redemption price at maturity) falls into one of two buckets. Either the bond was issued below face value — that is original issue discount — or it was issued at or near par but later traded down in the secondary market because interest rates rose or the issuer’s credit weakened — that is market discount. The tax code treats these two situations under completely different sections, IRC §1272 for OID and IRC §1276 for market discount.

Knowing which bucket your bond falls into is the most important step you will take. A reader who confuses the two can report income in the wrong year, claim the wrong basis, and convert a capital gain into ordinary income — or the reverse. The next step is to figure out which situation applies to you before you touch a single form.

Which Situation Applies to You?

The answer to “what’s my basis?” depends entirely on how your bond got its discount. Use this branch to find your path.

You bought a bond issued below face value (a zero-coupon bond, a Treasury STRIP, or a corporate bond sold at a discount when new). This is original issue discount. Read the OID section — you accrue income yearly and your basis climbs each year.
You bought a bond on the secondary market for less than its face value, and it was originally issued at or near par. This is market discount. Read the market discount section — your basis usually stays flat and the discount becomes ordinary income at sale.
Your discount is tiny — less than one-quarter of one percent of face value times the years left to maturity. This is de minimis discount. Read the de minimis section — you may get capital gain treatment instead of ordinary income.
You bought a tax-exempt municipal bond at a discount. Read the municipal bond section, because tax-exempt OID and taxable market discount follow different rules even inside the same bond.
You bought the bond at a discount but also paid accrued interest to the seller. Read the accrued interest section — that payment is not part of your basis and is handled separately.

Most retail investors hold a mix of these. Work through each holding one at a time, because applying the wrong rule to even one bond can flow a wrong number onto your Schedule D.

Original Issue Discount (OID) Bonds: Basis Climbs Every Year

Original issue discount is the gap between a bond’s face value and the lower price it was first sold for when the issuer created it. A zero-coupon bond is the classic example — it pays no cash interest, so it is sold deeply below face and pays full face at maturity. IRC §1272 treats that built-in discount as interest you earn a little at a time, every year, even though you receive no cash until maturity.

The consequence is that you owe tax on “phantom income” each year. You must include the OID that accrues annually as interest income on Schedule B, and you will receive a Form 1099-OID from the issuer or broker reporting the amount in Box 1. Skipping this income is a common audit trigger because the IRS receives a matching copy of that 1099-OID.

The upside is that every dollar of OID you report as income increases your basis by the same dollar. This is the rule that protects you from being taxed twice. If you did not raise your basis, you would pay tax on the OID as it accrued and then pay tax on it again as capital gain when you sold or redeemed the bond.

A common misconception is that a zero-coupon bondholder pays no tax until maturity because no cash arrives. That is wrong for taxable bonds, and ignoring it leaves you with years of unreported interest and a basis that is far too low.

What you should do: keep every Form 1099-OID, report the OID on Schedule B each year, and track your cumulative basis increases. When you finally sell or redeem, your basis is your original cost plus all OID reported across every year you held it. The accrual method is the constant yield method described in IRS Publication 1212, which front-loads less and back-loads more income than a straight-line split.

Worked Example: Zero-Coupon Treasury STRIP

Maria buys a zero-coupon Treasury STRIP for $7,500 in January 2020. It matures in January 2030 at $10,000 face value, so her total OID over ten years is $2,500. Using the constant yield method, suppose her 1099-OID forms report a cumulative $1,300 of OID income across 2020 through 2025.

By the end of tax year 2025, Maria’s adjusted basis is $7,500 + $1,300 = $8,800. If she sells the STRIP in 2025 for $8,950, her capital gain is only $8,950 − $8,800 = $150, taxed as a long-term capital gain. Without the basis bump, she would have wrongly reported a $1,450 gain and paid tax on the same $1,300 she already reported as interest over the years.

Market Discount Bonds: Basis Usually Stays Flat

Market discount arises when you buy a bond on the secondary market for less than its face value (or less than its revised issue price if it also has OID), and the bond was originally issued at or near par. Per the TaxBuzz market discount guide, this usually happens because interest rates rose after issuance or the issuer’s credit slipped. Market discount bonds do not include obligations maturing within one year, U.S. savings bonds, or tax-exempt bonds bought before May 1, 1993.

Here is the rule that surprises most investors: under IRC §1276, if you do nothing, your basis stays at your purchase price the entire time you hold the bond. The accrued market discount does not raise your basis year by year the way OID does. Instead, when you sell or redeem the bond, any gain is treated as ordinary income — not capital gain — up to the amount of accrued market discount.

The consequence is a higher tax rate. Ordinary income can be taxed up to 37% for tax year 2025, while a long-term capital gain tops out at 20%. So a $1,000 “gain” that is really accrued market discount can cost you roughly $170 more in federal tax than a true capital gain would.

A common misconception is that buying a bond cheap and selling higher always produces a capital gain. For market discount bonds, the law specifically recharacterizes that profit as interest income, and your broker will flag it in Box 1f of Form 1099-B.

What you should do: decide whether to make the §1278(b) election (covered next). If you do nothing, plan for ordinary income at sale, keep your basis equal to cost, and report the accrued market discount as both a basis-neutral adjustment on Form 8949 and as interest income on Schedule B.

Worked Example: Corporate Bond Sold at Maturity

David buys a $2,000 face corporate bond on the secondary market for $1,829 in November 2021. It matures August 2023 at $2,000. He makes no election. His total market discount is $171, and because he holds it to maturity, the full $171 has accrued.

At maturity David receives $2,000. His basis stays at $1,829. The $171 difference is all accrued market discount, so it is reported as ordinary interest income on Schedule B — not as capital gain. On Form 8949 he reports the sale with code D and a $171 negative adjustment in column (g) so the capital gain nets to zero, matching the Form 8949 instructions.

The §1278(b) Election: Accrue Now to Smooth It Out

You can choose to include market discount in income as it accrues each year under IRC §1278(b), exactly the way OID works. When you make this election, you report a slice of the discount as interest income annually, and — importantly — your basis rises by that same amount each year.

The benefit is that at sale there is little or no accrued discount left to recharacterize as ordinary income, and you have spread the income across several years. The cost is that you pay tax sooner and the election is irrevocable without IRS consent, and it applies to all market discount bonds you acquire that year and in every future year.

To make the election, attach a statement to your timely filed return stating that you are including market discount in income currently under IRC §1278(b) and describing your accrual method. Most investors weigh this against their expected tax bracket — accruing early helps if you expect to be in a higher bracket later or want to convert future ordinary income into smaller annual amounts.

Ratable vs. Constant Yield Accrual

Two methods exist to figure how much market discount has accrued. The ratable method, described in IRC §1276(b), spreads the discount in equal daily amounts: divide total discount by the days from purchase to maturity, then multiply by days held.

The constant yield method, an election under §1276(b)(2), accrues the discount based on a constant interest rate, the same engine used for OID and explained in IRS Publication 1212. Once chosen for a specific bond, the constant yield method cannot be changed for that bond. The ratable method usually accrues more in the early years; the constant yield method usually accrues less early and more later, which can defer income slightly.

The De Minimis Rule: When a Small Discount Stays a Capital Gain

The tax code gives small discounts a break. Under the de minimis rule, market discount is treated as zero if it is less than one-quarter of one percent (0.0025) of the face value, multiplied by the number of full years from your purchase date to maturity, per the market discount de minimis rule.

When your discount falls under that threshold, the unfavorable §1276 rule does not apply, and any profit at sale is treated as a normal capital gain instead of ordinary income. That is a genuine tax saving, because the capital gains rate is lower and the gain may qualify for the 0%, 15%, or 20% long-term brackets for tax year 2025.

A common misconception is that any discount means ordinary income. Not true — run the de minimis math first, because a small enough discount keeps you in friendlier capital-gain territory.

Worked Example: De Minimis Threshold in Action

Priya buys a $10,000 face bond with exactly 8 full years left to maturity. The de minimis threshold is $10,000 × 0.0025 × 8 = $200. If she paid $9,850, her discount is $150 — below the $200 threshold — so the discount is treated as zero and her eventual profit is a capital gain.

If instead Priya paid $9,700, her $300 discount exceeds the $200 threshold, so the full $300 is market discount taxed as ordinary income at sale (absent an election). The threshold is a cliff, not a deductible — cross it by a dollar and the entire discount becomes ordinary.

Municipal Bonds Bought at a Discount

Tax-exempt municipal bonds add a twist because part of the discount may be tax-free and part may not. For a muni with original issue discount, that OID is treated as tax-exempt interest — you do not pay federal tax on it, but you still increase your basis by the OID as if it were taxable, per guidance summarized by H&R Block on OID basis.

The consequence of raising basis on tax-exempt OID is that it prevents a phantom capital gain at sale. Your basis is your cost plus the OID you would have included if the bond had been taxable, so the tax-free growth is not later taxed as gain.

Market discount on a municipal bond is the opposite story: it is generally taxable as ordinary income at sale, even though the bond’s coupon interest is tax-exempt. Many investors are shocked to learn that a “tax-free” muni can still generate a taxable ordinary-income event when bought below par on the secondary market.

What you should do: separate the muni’s OID component (tax-exempt, raises basis) from any market discount component (taxable ordinary income at sale). Keep your broker statements and Form 1099-OID, which reports tax-exempt OID in Box 11, and confirm the split before you sell.

Accrued Interest Is Not Part of Your Basis

When you buy a bond between coupon dates, you often pay the seller the interest that built up since the last payment. This accrued interest is not part of your cost basis. Folding it into basis is a frequent error that distorts your gain or loss.

Instead, the accrued interest you paid is subtracted from the first coupon payment you receive, so you are not taxed on interest you effectively bought from the seller. You report it as an adjustment that reduces your taxable interest on Schedule B.

The consequence of mishandling it is double trouble: you would overstate your basis and overstate your interest income, paying tax twice on the same dollars. What you should do is record the accrued interest separately, reduce your reported interest income for it, and keep your bond basis equal to the price you paid for the bond itself, excluding that accrued amount.

How to Report Your Basis on the Forms

Reporting a discount bond touches three forms, and the codes matter. Here is the federal workflow for tax year 2025, drawn from the 2025 Form 8949 instructions.

Form 8949 (sale of the bond). Report the sale in the short-term or long-term section that matches your holding period. Enter your proceeds in column (d) and your basis in column (e). If Box 1f of your 1099-B shows accrued market discount, enter code D in column (f) and the accrued market discount as a negative number in column (g), which removes it from your capital gain. If your broker already adjusted your basis but you did not elect to accrue, use code B and correct the basis in column (g) instead.

Schedule D (totals). The columns from Form 8949 flow to Schedule D, where short-term and long-term gains are netted and carried to your Form 1040. This is also where the constant yield vs. ratable accrual ultimately changes your final capital-gain figure.

Schedule B (interest income). Report the accrued market discount as interest income on Schedule B, identified as “accrued market discount.” OID income from a 1099-OID also lands here; if the 1099-OID amount differs from your recomputed amount, list the difference below the line as an “OID Adjustment.”

The deadline is your normal return due date — April 15, 2026, for tax year 2025, or October 15, 2026, with an extension. Missing the income or using the wrong code typically generates a CP2000 underreporting notice from the IRS roughly 12 to 18 months after you file.

Three Common Scenarios at a Glance

These tables show how each discount type plays out at sale for tax year 2025.

Scenario 1 — Taxable OID Bond Held to Maturity

Holding Choice	Tax Result
Report OID income each year	Basis climbs yearly; little or no gain at maturity
Skip the yearly OID income	IRS CP2000 notice plus interest and penalties for unreported income

Scenario 2 — Market Discount Bond, No Election

Holding Choice	Tax Result
Hold to maturity, no §1278(b) election	Full accrued discount taxed as ordinary income at up to 37% for 2025
Sell early at a small profit	Gain is ordinary income up to accrued discount, capital gain only above it

Scenario 3 — Discount Under the De Minimis Threshold

Holding Choice	Tax Result
Profit at sale, discount below threshold	Entire profit is capital gain, taxed at 0%, 15%, or 20% for 2025
Profit at sale, discount above threshold	Discount portion is ordinary income; only the excess is capital gain

Named Examples Across Bond Types

Carlos and the corporate market discount bond. Carlos buys a $50,000 face corporate bond for $46,000 in 2023 with no election, then sells it for $49,000 in 2025. His accrued market discount through the sale date is $2,400. Of his $3,000 economic profit, $2,400 is ordinary income and only $600 is capital gain. His basis stayed at $46,000 the whole time.

Lena and the §1278(b) election. Lena buys a similar $46,000 bond in 2023 but elects under IRC §1278(b) to accrue currently. She reports about $1,200 of market discount income per year and raises her basis to roughly $48,400 by 2025. When she sells for $49,000, only $600 is left as capital gain and she already spread the rest across two years.

Tomas and the tax-exempt muni. Tomas buys a municipal bond with $1,000 of original issue discount and holds it to maturity in 2025. The $1,000 OID is tax-exempt interest, but he still raises his basis by $1,000, so redeeming at face value produces no taxable capital gain.

Mistakes to Avoid

Confusing OID with market discount. Applying the OID yearly-accrual rule to a market discount bond reports income in the wrong years and can create penalties for both over- and under-reporting.
Forgetting to raise basis for OID reported. This taxes the same OID twice — once as interest, again as a phantom capital gain at sale.
Skipping yearly OID income on a zero-coupon bond. The IRS receives your 1099-OID, so omitting it reliably triggers a CP2000 notice with interest.
Treating market discount profit as capital gain. Under §1276 it is ordinary income up to the accrued discount, costing you the rate difference of up to 17 percentage points for 2025.
Ignoring the de minimis test. A discount under the threshold is capital gain; missing this overstates your ordinary income and your tax.
Adding accrued interest to your basis. This overstates basis and overstates interest income, taxing the same dollars twice.
Trusting Box 1e blindly. A broker’s reported basis may not reflect your accrual election, so you must reconcile it with code B or D on Form 8949.

Do’s and Don’ts

Do keep every 1099-OID and 1099-B, because the IRS matches them and you need them to prove your basis.
Do run the de minimis math first, because it can convert ordinary income into a lower-taxed capital gain.
Do decide on the §1278(b) election early, because it is irrevocable and applies to all future market discount bonds.
Do report accrued market discount on Schedule B, because the law treats it as interest, not capital gain.
Do reconcile your broker’s basis, because Box 1e may not match your true adjusted basis.
Don’t assume a cheap bond means a capital gain, because §1276 often recharacterizes it as ordinary income.
Don’t forget OID raises your basis, because skipping the adjustment causes double taxation.
Don’t fold accrued interest into basis, because it belongs on Schedule B as an interest offset.
Don’t ignore municipal market discount, because it is taxable even when the coupon is tax-free.
Don’t make the §1278(b) election casually, because you cannot revoke it without IRS consent.

Pros and Cons of the §1278(b) Election

Pro: Spreads income over years, which can keep you out of a higher bracket at sale.
Pro: Raises basis annually, leaving little ordinary income to recognize at disposition.
Pro: Simplifies the sale-year math, because the discount is largely already reported.
Pro: Can convert a lump ordinary hit into smaller annual amounts, easing cash-flow surprises.
Pro: Aligns with OID treatment, simplifying tracking if you hold both bond types.
Con: Accelerates tax, because you pay on income before you receive any cash.
Con: It is irrevocable, so a change in your situation cannot undo it without IRS consent.
Con: It applies to all market discount bonds, removing your year-by-year flexibility.
Con: Adds recordkeeping, because you must accrue and track basis every year.
Con: May not help if rates are low, because the deferred-income benefit shrinks.

What to Do Next

Identify each discount bond’s type — OID, market discount, de minimis, or municipal — using your trade confirmations and 1099 forms.
Pull your Form 1099-OID and Form 1099-B and check Box 1f for accrued market discount.
Run the de minimis test on every market discount bond before assuming ordinary income.
Decide on the §1278(b) election if you hold market discount bonds — and remember it binds all future ones.
Report correctly on Form 8949, Schedule D, and Schedule B using codes B and D as needed, by April 15, 2026, for tax year 2025.
Call a CPA if you hold distressed debt, partial principal payments, stripped bonds, or large municipal positions — those situations involve nuanced regulations and a professional review usually costs a few hundred dollars but can prevent far larger errors.

This article is educational and is not a substitute for advice from a licensed tax professional for your specific situation.

FAQs

What is the cost basis of a bond bought at a discount?

Your purchase price, adjusted upward. For tax year 2025, add any OID you reported as income each year. For market discount, basis rises only if you elected to accrue it; otherwise it stays at your cost.

Is the discount on a bond taxed as capital gain or ordinary income?

Usually ordinary income. Market discount and OID are both treated as interest. Only a discount under the de minimis threshold, or profit above accrued market discount, qualifies as a capital gain for tax year 2025.

Does OID increase my cost basis?

Yes. Every dollar of original issue discount you include in income each year raises your basis by the same dollar, which prevents you from being taxed twice on the same amount when you sell.

Does market discount increase my basis?

Only if you elect to accrue it. Without a §1278(b) election, your basis stays at your purchase price and the accrued market discount becomes ordinary income at sale for tax year 2025.

What is the de minimis rule for bond discounts?

0.25% times years to maturity. If your discount is below face value times 0.0025 times the full years remaining, it is treated as zero and any profit is a capital gain, not ordinary income.

How do I report accrued market discount on my taxes?

On Schedule B and Form 8949. Report it as interest income on Schedule B, and on Form 8949 use code D with a negative column (g) adjustment so it is removed from your capital gain.

Where does accrued interest I paid the seller go?

It reduces your interest income, not basis. Subtract accrued interest you paid from your first coupon on Schedule B. It is never added to your bond’s cost basis.

Are municipal bond discounts taxable?

It depends on the type. Municipal OID is tax-exempt but still raises basis. Municipal market discount is generally taxable as ordinary income at sale for tax year 2025, even on a tax-free bond.

Can I avoid ordinary income on a market discount bond?

No, not entirely. Section 1276 requires ordinary-income treatment up to accrued market discount. You can only spread it over time with a §1278(b) election or stay under the de minimis threshold.

Is the §1278(b) election reversible?

No. Once made, the election to accrue market discount currently is irrevocable without IRS consent, and it applies to all market discount bonds you acquire that year and afterward.

What form reports OID income?

Form 1099-OID. The issuer or broker reports OID in Box 1 (and tax-exempt OID in Box 11). You include it as interest on Schedule B for the year it accrues, for tax year 2025.

What happens if I do not report my 1099-OID?

You risk a CP2000 notice. The IRS receives a matching copy, so omitting OID income typically triggers an automated underreporting notice plus interest and possible penalties within 12 to 18 months.

Related reading