How Municipal Bond Swaps are used to Lower Taxes

Municipal bonds have several tax advantages to investors, but only if proper strategies are used. Any of the three types of municipal security bonds can be exchanged for another, meaning, swapped. If this is done carefully a trader can benefit from much tax savings and also maintain a positive investor portfolio. .

The process of swapping is fairly simple. Any investor who owns a security in the market that is trading at a loss, can think of swapping as the next step to take to to enjoy tax savings. One thing to note is that any business person with a municipal bond currently trading at a discount, meaning less than its issued value or its par value, owns security selling at a loss too. Many business personalities therefore qualify to make use of this legally acceptable financial tool to help themselves.

Have a look at each of the security bonds. The first one is the market municipal discount bond. The security can occur due to increase in market interest rates or decline of trustworthiness in the issuer. However, you can swap this market Discount bond and gain tax benefits. Though it does not keep you safe from the tax man, it gives you the option to defer the taxes over the life of the product or till maturity. That is not the case with original issue discount bond. This security is considered tax –exempt. This is because the issuer issues the bond below par value. According to IRS, this discount is issuer –based and not market- based, therefore not taxable.

Finally, to consider is the premium bond products which are also tax exempt. It is possible to trade them in and save a lot of money. It is healthy to remember that they must always be amortized. Amortization is expected to cover the entire period in which you owe the bonds. The amortized amount here, is not deductible, because interest is tax free.

You will usually find these trade tools to share several traits such as rate, term, and call features, among others. What this means to your business is that, when bonds with such similar characteristics are swapped, then the composition of the investor’s portfolio may be affected. But it is necessary to note the exchange gives room to the trader (you) to sell the old bonds at a loss and reduce his/her taxable totals. Moreover, it is highly encouraged to swap bonds that adhere to the IRS ”Wash Sale” rule. It requires products being swapped to be different in at least two of these factors: coupon rate, coupon date or issuer.