Muni bonds capital, computing, equivalent

optiix

If capital gains on a muni bond ARE taxable, when computing a tax equivalent yield why do we use a yield and not coupon?

Taxable-equivalent yield= tax free yield / (1-marginal tax rate)

Mechanic

Capital Gains/Losses only come into play if you sell a bond before it matures and don't effect the tax equivalent yield at all.

Because a tax equivalent yield is built off of yield to MATURITY, the underlying assumption is that the municipal bond will be held until maturity. For tax purposes, "extra" income from accretion of a discount bound is treated and taxed as interest income, and the same thing applies for a corporate bond as well.

If I buy a 3% Municipal Bond at 98 and it matures in two years at 100, I am just telling the IRS my interest income is 3 + 1% (total of 4%) annually and I am not reporting any capital gains at all, which is what makes the whole thing work.

kmf229

oh, very interesting I didnt know that. thanks so much for your response.