March 18, 2022

MSRB Cautions Investors on Purchasing Discounted Bonds in a Rising Interest Rate Environment

Steven Lofchie Commentary by Steven Lofchie

The MSRB reminded investors of the "potential impact to investors of the current market environment on bond prices, liquidity and tax implications from buying certain types of municipal bonds in the secondary market."

The MSRB explained that bonds traded at a discounted rate may have substantially less liquidity than bonds traded at par or premium value. As a result, "if an investor needs to sell a bond that is at a significant discount, there may be fewer willing purchasers."

MSRB cautioned investors that if a bond is discounted below what may be considered a de minimis amount, the eventual proceeds from the bond may be considered ordinary income, rather than capital gains, and therefore taxed at a higher rate. The MSRB urged investors to consider whether the higher yield on a discounted bond is sufficient to compensate for the potential greater tax liability and for any liquidity risk resulting from holding the bond.

Commentary

Although the MSRB document is addressed to investors, both broker-dealers and investment advisers should consider the suitability issues raised by the MSRB's statement.  

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