7699 / What tax limitations apply to the holder of registration required bonds that are not in registered form?

Income from otherwise tax-exempt bonds that do not meet the registration requirement (see Q 7698) is not exempt from federal income tax in the hands of a U.S. person. However, this limitation does not apply to interest exempt from tax by the United States under a treaty.¹

Loss on the sale, exchange, theft, loss, etc., of a registration required obligation that would be tax-exempt if registered is not deductible if the obligation is not in registered form.² Gain on sale or exchange of a registration required bond that would otherwise be tax-exempt but that is not registered must be treated as ordinary income. It is denied capital gain treatment.³ These sanctions also apply to U.S. persons holding unregistered bonds that are not required to be registered because they were designed for distribution outside the United States.⁴

Regulations allow the loss deduction and capital gains treatment by a holder who, within 30 days of the date when the seller or other transferor is reasonably able to make the bearer obligation available to the holder, surrenders the obligation to a transfer agent or to the issuer for conversion into registered form.⁵