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<<I sold some zero coupon bonds (Treasuries) this past year and have been struggling to find a source for how to report the sale. Schedule D doesn't seem quite right, because the most (all?)of the proceeds are Treasury interest and should be tax-free (on the State level, taxable on the 1040 level).>>

I had a discussion on this very issue not too long ago. You might want to check it out. It can get pretty complicated, depending on how long you held the bonds, etc.

Remember that you've been required to "recognize" interest income in the years that you held the zero. In general, that income that you have been required to recognize (original issue discount...or OID) actually adds to your original cost basis. Then you compare your cost basis with your sale price and report the sale transaction on Schedule D.

Even though the zero might be a Treasury zero, gain or loss on the sale transaction is certainly reportable for both federal and state purposes. It's only the interest that's taxable at the federal level (but not subject to tax at the state level).

Hope this helps...
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