Personal Finance: GM bonds not typical situation

Question:

I have always invested in bonds because I like certainty. Several years ago, I bought General Motors bonds. I thought I could rely on a car company, and the interest rate was good. Now I find out that my bonds are going to be converted into stock by the Bankruptcy Court. What happens if I sell the stock after I get it? Will there be tax consequences?

Answer: For a person who likes certainty, the GM bankruptcy must be disconcerting. It's a vivid example of what can happen to people who buy bonds in a well-known company that deteriorates financially over time.

Whenever people buy corporate bonds, there is a chance the company's financial strength will change, and a person could lose money. In a bankruptcy, bondholders generally lose part of the money they invested, and they can lose everything. That's why bondholders - like stock investors - must monitor the company to make sure its financial conditions are not worsening.

Attentive GM bondholders could have recovered much more than now. In 2005, some analysts predicted bond investors would lose half the value of their holdings in a possible bankruptcy.

Now, instead of receiving any money, bond investors will get stock that may or may not increase in value. Estimates are that bondholders might get about 20 percent of the value of their bonds in stock, but that is fluid and probably will not be resolved until next year. Once you receive stock, you can sell it if a broker can find a buyer. But that is not likely to be the best move. Eventually, the new GM is supposed to have an initial public offering. Estimates are that this will occur in the second half of next year.

At that point, you will be like anyone else who owns stock in a company that trades in the market. The price will go up and down. In theory, the new GM should do better than the old one because the Bankruptcy Court wiped away some debts.

Typically, people who sell a stock that has increased in value since the purchase experience a capital gain. They have to tell the IRS how much they made on the stock compared with what they paid and get taxed on the profit.

If you hold a stock for at least a year after buying it, the gain is taxed at a maximum 15 percent rate. But if you sell it less than a year after buying it, you have a short-term gain and will be taxed at your regular tax rate. For many people, that means more than 15 percent.

Still, if the tax situation has been bothering you, the General Motors transaction is different from typical stock purchases. Instead of buying the stock, you received it in exchange for your bonds, so what matters is the date of maturity on the bonds, not the date when you receive the stock, said Andy Cordonnier, a certified public accountant at the global firm Grant Thornton L.L.P.

This occurs whenever a bankrupt company's bonds are converted into stock.

If you bought bonds years ago, receive stock as a result of the bankruptcy, and sell the stock shortly after, you do not have a short-term capital gain. In fact, if you look at what you originally invested in the bond, you probably lost a lot on the transaction.

Say, for example, you put $10,000 into GM bonds a few years ago. Now, they are worth little. If you receive stock valued at $2,000 soon, you will have lost $8,000 of your original investment on paper. If you sell the stock at $2,000, you would have an $8,000 loss for tax purposes.

The loss would reduce gains on other investments, or you could apply $3,000 to regular income and use the remaining $5,000 in future tax years.

Now, say you receive $2,000 in stock, and you sell it a couple of months later at $2,200. Cordonnier said you would not owe anything on the $200 gain because you still lost money, about $7,800, from the original value of the bond you bought.