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A simple example: suppose you buy a $10000 TIPS at auction for a fixed rate of 2%. ....

Thanks for the example. It really cleared things up for me. I have been trying to follow the details of TIPS and I-bonds, but my eyes kept glazing over. Loki's post made finally made it all clear.

Now for a question that was probably answered when my eyes were glazed over. How are taxes treated? For TIPS, do you pay taxes only on the interest payment, treated as income, and then on the increased principal, treated as capital gains at the end?
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