Final answer:
Interest from municipal bonds is exempt from federal taxes, while capital gains realized from purchasing a bond at a discount and selling it at par at maturity are subject to federal taxes.
Step-by-step explanation:
When a municipal bond is bought in the secondary market at a discount and held until maturity by the purchaser, the following apply:
- Interest is exempt from federal taxes, as this is one of the key benefits of municipal bonds.
- The capital gain is subject to federal taxes. This is because the gain realized is the difference between the purchase price of the bond (at a discount) and its par value at maturity.
- Interest is not subject to federal taxes, reiterating the tax-exempt status of municipal bond interest.
- The capital gain is not exempt from federal taxes, as capital gains on most investments, including discounted bonds sold in the secondary market, are typically taxable.