Can I deduct defaulted Treasury bonds from my taxes owed

Question

I purchase a U.S. Treasury bond. If the government doesn't repay it, may I deduct the face value of the bond from my income tax payment?

Answer 1

If that ever happens, I think you would claim it as a capital loss, just as if you lost any other investment. A percentage would probably be deductable, not the whole thing.

The odds of it ever happening are pretty negligible, though. A lot more would have to go wrong in the country first.

(Political opinion withheld as a public service.)

Answer 2

If the government defaults on its bonds, it still owes you the money. Therefore, the bonds will not automatically be worthless; rather, they will trade at some reduced value. Just how much the value is reduced depends on the market's perception of how likely it is that the bonds will be repaid and how long it will take to get the money, if they are repaid. This actually happened once before, in 1979. Treasury prices dropped enough to cause a 60-basis point increase in their yield.

The tax implications would depend on whether or not you sell the bonds after the default. If you sell, you will realize a capital loss, which you would be able to deduct under the normal rules; however, that loss would be considerably less than the full face value of the bond. If you hold onto the bond, then you will have an unrealized capital loss. Capital losses are not deductible until you realize them, just as gains are not taxable until you realize them, so in that case there would be no immediate effect on your taxes.