Here's how: Let's say that two years ago you bought a five-year corporate with a 6% coupon and paid its $1,000 face value. Interest rates have since fallen, so now the bond sells for $1,120 and yields 2% to maturity.STEP ONE
You sell the bond, netting $120. Come Apr. 15, you'll owe long-term capital gains taxes. (We'll assume the maximum 20% rate.)STEP TWO
You immediately buy back the bond. Over the next three years, until the bond matures, you'll continue to owe income taxes on the coupon payments of $60 a year. (We'll assume the top 38.6% federal rate.) But you also get to write off that $120 premium you paid for the bond. That slashes $40 a year off that taxable income.THE RESULT
After taxes, you'll earn a 4.4% annual return on the bond, vs. 3.6% if you simply hold it to maturity.
To see if this strategy is worth it in your situation, use the handy bond calculator at twenty-first.com. By Susan Scherreik