What's the best way to manage bonds which accrue tax-deferred interest?

Question

I have bonds bought with taxable funds which periodically accrue interest which is not taxable until the bond is redeemed, at which time it is taxable as ordinary income.  What is the best way to manage these bonds in Quicken?

26@harrich · Answer

This is a Series I US Savings Bond where I can choose to pay taxes on interest annually as it accrues or defer taxes until I redeem the bond.  I am electing to defer taxes since it is not only to my tax advantage but requires much less paperwork.  Unless someone comes up with a better approach, I will do the following:

(1) Enter the purchase as a Buy Bonds transaction for ([$ purchase amount]/$100) bonds at a bond price of $100.

(2) Each time interest is credited to the bond, adjust the bond price to ([$ new valuation] / [number of bonds]).

(3) On redemption (a) reinvest the accrued interest at a bond price of $100, and (b) sell the bonds at a bond price of $100.  In the year of redemption, this should result in a capital gain of $0, and taxable interest income equal to the total amount of accrued interest.  This should avoid the Return of Capital transaction which has troubled me in the past.

Thanks, all, for your ideas.

Tom Young · Answer

I corrected my typo.  It's the income you can either elect to report annually or defer until the sale or maturity of the bond for tax purposes.
If you're accruing the interest on the bond then I'd say just include that interest as income in your regular Spending reports.  If you're reporting the interest for income tax return purposes and the bond's in an after-tax Account, then that interest income should be reported on the Tax reports as well. 
If you're not reporting the interest income for tax purposes and it shows up in a Tax report. (offhand I can't remember if you can exclude income from certain securities in an after-tax Account from a Tax report), then just ignore it, don't include it in your income tax return.  That's a book-tax difference.

In that case the cash received (principal + years of interest) should be used as "proceeds" for a sale with a capital gain of $0 and all those years of accrued interest gets reported in your income tax return.  That's a reversing book-tax difference.

q_lurker · Answer

@Tom Young

Did you say what you meant there - "include the taxes"?  If so, can you clarify?  Is the interest included as tax-free interest or excluded, user choice?

From your first paragraph, I understand the negative RtrnCap and the positive IntInc transactions generate no change to the account's cash balance.  Per the referenced discussion, should the account (or security) then be included or excluded from the various Quicken reports for the current year?  How does this process (RtrnCap + IntInc each year) then generate taxable interest income when the bond matures as the OP suggests is proper?  My understanding was the the user wanted to defer recognizing the interest income until the bond matured.