Valuation and taxation of Death Put Bonds
Before 1971 certain bonds were issued by the U.S. Treasury known as “Flower Bonds”. These bonds, also called “Estate Tax Anticipation Bonds” would be issued at an amount less than their face value and would mature either at a fixed future date (the last expired in 1998) or would “flower” at the date of death of the bondholder. The idea was to provide funds to pay the deceased’s estate tax.
This concept has been adopted by the private sector with bonds that are issued at a discount and that will mature many years later. The bonds pay the investor a somewhat reduced yield, usually 10 to 15 basis points less than the current bond market yield. This lower yield is a result of the bonds containing a unique feature that allows the bonds, as an option, to be redeemed at their face value at the death of the bondholder, regardless of their current market value or their stated maturity date. These bonds have this right, known as a “put” option. The bonds are therefore called Survivor Option Bonds, or more commonly; “Death Put Bonds”.
The put option allows the decedent’s heirs to require the bond issuer to buy back (“put”) the bond at face value when the owner dies. If the market value of the bond is less than its face value the estate can realize a profit on this redemption. If the market value is higher than the face value the option would not be exercised, and instead just be allowed to lapse.
These Death Put Bonds usually have some restrictions such as the investor/bondholder may have had to hold the bond for a certain minimum amount of time – usually six months to a year. There could be limitations imposed by the issuer on how many bonds, overall, will be redeemed in any given year or how many bonds an individual investor may redeem in any calendar year.
The option to put back the bonds is a decision made by the beneficiaries following the death of the investor. There will be a time limit for this survivor option – most commonly the option is for one year following the investors’ death. An investor needs to be familiar with the specific restrictions of a death put bond before purchasing it.
In addition to the put back feature, the tax benefits of these bonds are also very favorable. The estate will get a step-up in basis to the full face value at death. The gain realized, therefore, on the buy-back will be tax free even if redeemed for an amount higher than the current market value or original cost. If the total value of the estate, including these bonds, is less than the estate exemption amount (currently just over $5.4mil) there will be no estate tax consequence. The entire sale will be income and estate tax free.
These bonds may not be appropriate for everyone. They do, however, offer an interesting investment option for older people and as a general estate planning strategy. Contact your ShindelRock tax professional for more information.
3 thoughts on “Valuation and taxation of Death Put Bonds”
I mostly agree with the first post. Interest rates ulasluy start to rise when the economy is doing better. When the economy is doing better then the companies that sold the junk bonds generally are more secure so the interest rates for junk falls or stays the same. And the higher yield becomes more attractive. But that only works for a while. When Fed starts raising rates high enough to slow the economy then junk gets hurt more because they more risky and generally more in debt. To simplify they perform better at first and worse later because you are weighing two factors, interest rates against default risk.
Could you advise me where the code or some tax letter/case says that when a survivor’s option is exercised then the full face value will be the value for basis. I have a brokerage firm that insists on reporting the basis as the market value on date of death (which was less.) I feel that the Trustee had a fiduciary duty to exercise the option and that the value at date of death was the contract value. What I have found – what a willing seller and a willing buyer would transact and that the code does not look favorably on restrictive contracts among family members…does not convince the brokerage. Is there anything out there on point?
Thanks for the great question Greta. Your question is one that would require an individualized understanding of the facts and circumstances to give you the accurate research. Please contact us if you’d like to have us assist you in this matter.
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