Final answer:
Daniel must recognize $600 in interest income for 2019, as it is the interest he received for the year. When selling the bond in 2020, there is a $100 capital loss because he sold it for $10,200, but the adjusted cost basis was $10,300, including the $300 accrued interest he paid at purchase.
Step-by-step explanation:
When analyzing Daniel's bond transactions, we must consider the cost of the bond, the interest accrued, the interest received, and the sale price. On July 1, 2019, Daniel purchased the bond at its par value of $10,000 and paid an additional $300 for accrued interest. By December 31, 2019, he received $600 in interest for the year. On January 1, 2020, Daniel sold the bond for $10,200.
For the 2019 tax year, Daniel must recognize $600 in interest income, which is the total interest payment he received for the year. However, the $300 he paid for accrued interest when he bought the bond does not factor into the interest income because he essentially reimbursed the seller for interest that had accrued prior to his purchase—interest for which the seller was entitled but had not received. Therefore, this $300 should be considered part of the cost basis of the bond rather than income.
Concerning the sale of the bond in 2020, we calculate the gain or loss by comparing the sale price to the adjusted cost basis. Since he purchased the bond at par value plus accrued interest, the total cost basis is $10,300 ($10,000 + $300). Selling the bond for $10,200 results in a $100 loss ($10,200 - $10,300). Consequently, there is a capital loss, not a gain, on the sale of the bond.
Based on this information, the correct answer to the student's question is: Daniel must recognize $600 interest income for 2019 and a $100 loss on the sale of the bond in 2020.