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as income or capital gains? Two reasons: 1) Depending on your tax bracket, capital gains are generally taxed at a lower rate than regular income, 2) Interest payments on some bonds are tax free, while the money realized by trading them is always taxed at the capital gains tax rate. For example, Treasury bond interest payments are exempt from state and local taxes, and munis are exempt from federal taxes and, if bought in the buyer's home state, from state taxes as well. But if the holder of these bonds decides to sell them in the bond market for a profit, he will be taxed on the gains.

By the same token, losses realized on the sale of bonds are considered capital loss and can be used (within defined limits) as deductions to reduce taxable income and ultimately lower taxes. Bonds which go in default may also be used as deductible items (within defined limits) to reduce taxes, since they constitute a loss for their holders. Important advice here is not to take chances with your tax return. Make sure to consult official tax guides or with your tax adviser to fully comply with the tax laws governing capital gains and losses, which may ultimately go to minimize your tax obligations, or at least save you from a tax audit.

Investing In Bonds

Bonds can be obtained from financial institutions such as banks, brokerage houses, investment firms, and sometimes directly from the issuer. For example, for Treasury bonds, the TreasuryDirect program allows direct purchase of Treasury securities from the Department of Treasury. Perhaps you are wondering what kinds of bonds would be suitable for you to invest in. That really depends on your personality and your goals. For example, your patience, risk-tolerance, and future goals can determine your best approach to investing in bonds. The truth is that perhaps there are as many types of investments as there are investors. But let's look at three broad categories. …