A tax free zero coupon bond is issued with a yield to maturity of 3.5%. After some time, an investor buys the bond at 50. ( 50 cents on the dollar ). When he buys the bond, the bond has a yield to maturity of 3.4%. After some time, he sells the bond for 80 cents on the dollar. In computing his cost basis in the bond, for tax purposes, should he use the 3.4% interest rate or the 3.5% interest rate? I believe he should use the 3.5% interest rate which will save him tax money.
The investor is in the United States.