Is a loss on the sale of a municipal bond deductible?

While interest on municipal bonds is tax free for federal income tax purposes, gain or loss on the sale of the bonds must be reported. The loss is treated as a capital loss, which is deductible within capital loss rules. This means the capital loss can fully offset capital gains. Any excess losses can then offset ordinary income up to $3,000 ($1,500 for those who are married filing separately). If the loss is not fully used up, it is carried forward to the following year and applied in the same way.