Government National Mortgage Association guaranteed bonds have a lot of positive features for investors. The interest and principal payments are guaranteed by Ginnie Mae, you earn an attractive rate of interest and GNMA mortgage bonds make payments every month. However, GNMA bonds do not have much in the way of tax advantages.
The interest earned from a GNMA mortgage-backed bond is fully taxable on both your federal and state income tax returns. Your investment broker will send a 1099-INT at the end of the year reporting how much you earned from your bonds and that interest will go on your tax returns as taxable income. The tax rate for the interest will be the same as your regular income tax rate.
The monthly payments you receive from a GNMA bond is not entirely composed of interest. Ginnie Mae bonds are mortgage pass-through securities and the monthly payments will include some repayment of principal as well as your interest earnings. Only the interest portion of the payments from your GNMA bond is taxable income and the 1099 will break down what portion of what you received was interest and what was return of principal.
Return of principal from a GNMA bond comes back at par value. If you paid a premium for the bond or bought it at a discount, the principal is worth less or more than you paid for it. For example, if you paid a price of 105 -- $105,000 for $100,000 of face value -- each $1,000 you get in returned principal costs you $1,050. With a GNMA purchased at a discount, you get back more than you paid with principal repayment.
It is very probable that you paid a premium for your GNMA bond and those losses on the return of premium are tax-deductible capital losses. When you get a $1,000 in principal back from a bond you treat the result as the payoff of a $1,000 bond, and if you paid $1,050 for that bond you have a $50 loss. The result would be claimed as a long- or short-term capital loss, depending on how long you have owned the GNMA bond. If you did buy your GNMA at a discount, the price gain must be claimed as a capital gain.