Selling a T-Bill Early: How §1271 Splits Your Gain on the 1099-B

The short answer: the gain on an early T-bill sale is not simply a capital gain. Under 26 USC §1271(a)(3), only part of your gain on a Treasury bill sold before maturity counts as ordinary interest income — specifically, a ratable share of the acquisition discount based on how many of the bill’s total days you actually held it. Whatever gain is left over, if any, is short-term capital gain, and if your entire gain is smaller than that ratable share, the whole thing is interest and there is no capital gain at all.

The moment usually arrives in late January or February, when the 1099-B from your brokerage finally lands. You sold a 26-week Treasury bill three or four months early because you needed the cash, or because a better rate showed up elsewhere, and you assumed the modest profit you pocketed would show up as a short-term capital gain like any other security held less than a year. Instead there’s a number sitting in box 1f labeled “accrued market discount,” and it’s eating into a gain you thought was straightforward. Nothing about the transaction felt complicated at the time — you bought a bill at auction, you sold it early, you made a little money — so the appearance of a second tax category on a single trade feels like the broker made an error. It didn’t. The federal tax code has a specific, and specifically worded, rule for exactly this situation, and once you see the formula it applies, the box 1f number stops looking arbitrary.

The §1271 ratable-share rule, explained

The controlling language sits in 26 USC §1271(a)(3), and it’s worth reading in the government’s own words before translating it: “On the sale or exchange of any short-term Government obligation, any gain realized which does not exceed an amount equal to the ratable share of the acquisition discount shall be treated as ordinary income.” The statute then spells out exactly how to compute that ratable share, as “an amount which bears the same ratio to such discount as—(i) the number of days which the taxpayer held the obligation, bears to (ii) the number of days after the date the taxpayer acquired the obligation and up to (and including) the date of its maturity.”

Strip away the legal phrasing and the mechanics are simple arithmetic: take the discount you originally locked in at auction, multiply it by the fraction of the bill’s life you actually held, and that product is the amount of any gain that gets recharacterized as ordinary income rather than capital gain. The statute does leave one door open for taxpayers who want it — an election to accrue the discount under a constant interest rate method, compounded daily, instead of the straight ratable formula. Most individual investors never make that election, so the ratable-share default is what shows up on the overwhelming majority of 1099-Bs.

Why T-bills get “acquisition discount,” not “market discount”

Here’s where a lot of forum threads and even some tax software walk-throughs blur two related but distinct regimes, and it’s worth being precise about which one governs a T-bill. Under 26 USC §1283(a), a “short-term obligation” is any bond, note, certificate, or similar instrument “which has a fixed maturity date not more than 1 year from the date of issue.” Every Treasury bill qualifies, since bills are issued with terms of a year or less by design. For a short-term obligation, the discount you bought at — the gap between the bill’s stated redemption price at maturity and your basis — is defined as “acquisition discount,” and it falls under §1271(a)(3), the ratable-share rule above.

Market discount, by contrast, is the regime under §1276, and it applies to longer-dated bonds bought at a discount on the secondary market after issuance — a ten-year Treasury note purchased below par from another investor, for instance. Because a T-bill is a short-term obligation from the moment it’s issued, its discount is acquisition discount, not market discount, even though your broker’s 1099-B will label the line item “accrued market discount” regardless of which statute technically applies. In practice, the reporting mechanics and the Form 8949 treatment end up identical either way, so the distinction won’t change what number you write down. What it does explain is why that box 1f figure scales precisely with the number of days you held the bill: it’s not an estimate or a broker convention, it’s the ratable-share formula from the statute, run automatically.

Running the numbers on a 26-week bill

A concrete example makes the split easier to see than the statute’s language alone. Say you buy a 26-week bill with $10,000 of face value at auction for $9,810, which sets your acquisition discount at $190. You hold it for 91 of the bill’s 182 days and then sell it for $9,915.

Your ratable share is $190 multiplied by 91/182, which comes out to $95. Your total gain on the sale is $105 — the $9,915 you received minus the $9,810 you paid. Because your gain exceeds the ratable share, the split falls exactly along that line: $95 is ordinary interest income, and the remaining $10 is short-term capital gain.

Change the sale price and the outcome changes with it. Sell that same bill for $9,880 instead, and your total gain drops to $70 — less than the $95 ratable share. When the gain is smaller than the ratable share, the entire gain gets treated as ordinary interest, full stop, and there’s no capital gain left over to report; the capital gain tranche is $0. And if you sell below your $9,810 basis, none of this applies at all — a loss on a short-term Government obligation is simply a capital loss, since §1271(a)(3) only recharacterizes gains, never losses.

What shows up on your 1099-B and Form 8949

Your broker does this arithmetic for you and reports the result in box 1f of the 1099-B, “accrued market discount.” The Form 8949 instructions tell you exactly what to do with that figure: “Enter the accrued market discount from box 1f on Form 1099-B,” using code “D” in column (f) whenever “You received a Form 1099-B… showing accrued market discount in box 1f.” That amount then gets entered “as a negative amount (in parentheses) in Form 8949, column (g),” which backs it out of the capital gain calculation. The instructions add one more step in the same breath: “Also, report it as interest income on your tax return.” In other words, the negative adjustment on Form 8949 isn’t the end of the paperwork — the same dollar figure needs to reappear as interest income elsewhere on your return, or you’ll have removed it from your capital gain without ever taxing it as the ordinary income it is.

Does your state tax the interest portion?

There’s a state-level wrinkle worth flagging before you close the file. Under 31 USC §3124(a), “stocks and obligations of the United States Government are exempt from taxation by a State or political subdivision of a State,” with narrow carve-outs for a nondiscriminatory franchise tax and for estate or inheritance tax. That exemption covers the interest income a Treasury bill generates, which is exactly what the ordinary-income portion of your ratable share represents. The practical complication is that states don’t all handle the mechanics of pulling that box 1f figure out of state taxable income the same way, so it’s worth checking your specific state’s instructions for how the subtraction is entered rather than assuming your software does it automatically. If you’re weighing whether a T-bill you might sell early still beats a high-yield savings account or a money market fund after this tax treatment is factored in, our T-bills vs. HYSA vs. money market comparison walks through that math. And if you haven’t sold yet and are wondering how the mechanics of an early sale even work, start with how to sell a T-bill before maturity on TreasuryDirect — this page picks up where that one leaves off, at tax time. For the rest of how Treasury income gets reported, see the taxes hub.

Sources

• Legal Information Institute, 26 USC §1271 — Treatment of gain from disposition of certain debt instruments: https://www.law.cornell.edu/uscode/text/26/1271
• Legal Information Institute, 26 USC §1283 — Definitions and special rules for short-term obligations: https://www.law.cornell.edu/uscode/text/26/1283
• Legal Information Institute, 31 USC §3124 — Exemption from taxation: https://www.law.cornell.edu/uscode/text/31/3124
• IRS, Instructions for Form 8949: https://www.irs.gov/instructions/i8949
• Your brokerage’s Form 1099-B, box 1f, reports the accrued acquisition discount for you at the time of sale.