Treasury STRIPS: Purchase Price, Maturity Value and Phantom Income

One payment, three different numbers

A Treasury STRIP can cost far less than its maturity payment and still generate taxable income before paying you anything. Keep three numbers separate: the purchase price you pay, the face amount due at maturity, and the original issue discount (OID) allocated to each tax year. A rising tax basis is not a cash deposit or a promise that your brokerage quotation will rise smoothly.

STRIPS separate a Treasury security’s principal and interest payments into individual zero-coupon securities. Each piece makes one payment at its own maturity. Purchases and holdings go through a financial institution, broker, or dealer, not a TreasuryDirect account. This article covers nominal, fixed-payment STRIPS, not inflation-linked pieces.[1]

The discount is not an annual return

Consider a hypothetical STRIP paying $10,000 exactly five years from purchase. Assume a 5% effective annual yield, annual compounding, and no fees or taxes. Its calculated price is $10,000 ÷ (1.05 × 1.05 × 1.05 × 1.05 × 1.05) = $7,835.26. This is an illustration, not a current quote or a dealer yield convention.

The $2,164.74 difference is the total modeled growth over five years. It is neither a 21.65% annual yield nor five equal interest installments. The effective annual return in this assumed hold-to-maturity model is 5%, before costs and taxes. The face amount is the eventual payment, not the amount of cash invested today.

Growth without a coupon

Using unrounded intermediate values, the same hypothetical annual-compounding model produces:

• Year 1: $7,835.26 opening value; $391.76 growth; $8,227.02 closing value.
• Year 2: $8,227.02 opening; $411.35 growth; $8,638.38 closing.
• Year 3: $8,638.38 opening; $431.92 growth; $9,070.29 closing.
• Year 4: $9,070.29 opening; $453.51 growth; $9,523.81 closing.
• Year 5: $9,523.81 opening; $476.19 growth; $10,000.00 closing.

Independent rounding can leave a one-cent difference within a row. No coupon cash arrives in years 1–4; the single $10,000 payment arrives at maturity. These are modeled accumulation values, not predicted resale prices.

This is not a tax-return schedule. IRS Publication 1212 applies stripped-bond rules using acquisition price, yield, accrual periods and daily OID allocation. Purchase dates, partial years and the applicable calculation conventions matter; do not copy these annual figures into a return.[2]

Why “phantom income” appears

In an ordinary taxable account, OID generally enters federal taxable interest income as it accrues, even without a cash payment. That timing mismatch is called phantom income: you may need other cash to pay the tax. For a purchased stripped bond or coupon, the IRS generally treats the purchase date as its original issue date and the excess maturity payment over purchase price as OID. Do not automatically apply an ordinary coupon bond’s secondary-market discount analysis instead.[2]

OID included in income increases basis, so previously recognized discount is not simply taxed again as the entire purchase-to-redemption difference. Preserve acquisition and basis records; an early sale requires its own calculation using adjusted basis. Treasury interest is federally taxable but exempt from state and local income taxes; that does not make every gain on an early sale exempt.[2][5]

Check the form and the account

For Treasury obligations, Form 1099-OID reports OID in box 8, not the general box 1. Publication 1212 specifically warns that box 8 for a stripped bond or coupon may not equal the proper amount to include in income. Reconcile the form with your purchase details and ask the broker or a qualified tax preparer about discrepancies; a missing form does not itself erase taxable OID.[2][3]

Account treatment differs. Earnings inside a traditional IRA generally are not currently taxed until distribution; qualified Roth IRA distributions can be tax-free. IRA recipients are generally excepted from Form 1099-OID reporting. These are account-level rules, not a claim that STRIPS become universally tax-free. Eligibility, withdrawals and distribution conditions still matter.[3][4]

Before comparing prices

Separate maturity cash from annual tax cost and possible resale proceeds. In the same discounting model, a higher required yield means a lower present price; needing to sell early can therefore produce a loss. Fixed dollars also do not fix future purchasing power. Check maturity, face amount, total execution cost and how you would fund any annual tax.

This is not a short-term Treasury-bill discount-yield calculation, a coupon bond’s clean-versus-dirty settlement adjustment, or a TIPS inflation-principal calculation. It explains a different mismatch: one future cash payment versus income recognized along the way. No live price, after-tax return guarantee or individualized tax recommendation is provided.