To buy municipal bonds directly, you open an account with a registered broker-dealer, research individual bonds on the MSRB’s EMMA system, and then place an order either during a new issue’s primary offering or on the secondary market from another investor. Most bonds require a minimum purchase of $5,000, and the interest is generally exempt from federal income tax under 26 U.S.C. § 103.1Office of the Law Revision Counsel. 26 U.S. Code 103 – Interest on State and Local Bonds The mechanics below walk through each step, plus the tax and risk checks worth doing before you commit money.
Open a Brokerage Account
You need an account with a broker-dealer registered with the Securities and Exchange Commission. On the application, you’ll provide your Social Security or Tax Identification Number along with details about your income, net worth, investment experience, risk tolerance, and goals. Your broker uses this to build a suitability profile. Under MSRB Rule G-19, the broker must have a reasonable basis to believe any bond it recommends fits your financial situation, tax status, investment timeline, and liquidity needs.2MSRB. Rule G-19 Suitability of Recommendations and Transactions
Once the account is open, you can search for bonds by CUSIP — a nine-character code that uniquely identifies each security3CUSIP Global Services. About CGS Identifiers — or browse inventory by issuer, state, maturity, or credit rating. Most municipal bonds are issued in a minimum denomination of $5,000, the smallest amount you can typically buy or trade. Some local issues start at $1,000; others aimed at institutional buyers set minimums of $25,000 or $100,000.4Municipal Securities Rulemaking Board. How Are Municipal Bonds Quoted and Priced
Research a Bond on EMMA Before You Buy
Once you’ve identified a bond, pull its Official Statement from the Electronic Municipal Market Access (EMMA) system, a free public website run by the MSRB.5Securities and Exchange Commission. Exhibit 4 – Electronic Municipal Market Access (EMMA) Functionality The Official Statement is the bond’s primary disclosure document, similar to a prospectus for a stock, covering repayment terms, legal opinions, the issuer’s financial health, the source of funds backing the bond, and any early redemption rights.6MSRB. Official Statements
Focus on two things. First, what actually backs repayment. Second, the bond’s call provisions, which spell out whether and when the issuer can pay the bond off early. EMMA also shows recent trade prices and volumes for the specific bond, so you can judge whether the price your broker is quoting is in line with the market.
General Obligation vs. Revenue Bonds
Municipal bonds fall into two broad categories based on what stands behind repayment.
- General obligation bonds are backed by the full faith and credit of the issuing government, which can raise taxes to pay bondholders. They are considered among the safest municipal investments because the issuer’s entire taxing power stands behind the debt.7MSRB. Municipal Bond Basics
- Revenue bonds are backed by income from a specific project or source, such as toll roads, airports, water systems, hospitals, or universities. If the project underperforms, the issuer has no obligation to use general tax revenue to cover the payments.7MSRB. Municipal Bond Basics
Revenue bonds typically carry slightly higher yields to compensate for that narrower repayment source.
Credit Ratings
Moody’s, Standard & Poor’s, and Fitch grade bonds on the issuer’s ability to repay on time. Moody’s runs from Aaa down to C; S&P and Fitch use AAA through D. Anything rated Baa/BBB or above is investment grade. Below that, the bond is speculative and carries significantly higher default risk. You’ll find ratings on EMMA and on your brokerage platform. An unrated bond isn’t automatically dangerous, but with no independent evaluation you’ll lean harder on the Official Statement. If you plan to hold to maturity, credit quality mostly affects whether the issuer keeps paying interest; if you might sell early, a downgrade can cut the bond’s resale value even when payments never stop.
Buying in a Primary Offering
A primary offering lets you buy directly from the issuer at the initial price, before the bond starts trading. To participate, you place a conditional order with your broker during the order period, which usually lasts only a few hours or a single business day. Your broker submits the order electronically with the dollar amount and how many bonds you want.
Primary offerings are sometimes oversubscribed, meaning total orders exceed supply. When that happens, the issuer follows a priority system to allocate bonds. In many retail-oriented offerings, individual investors receive priority over institutional buyers. After allotment, your broker sends a confirmation showing how many bonds you were awarded, the price, and the expected yield. That confirmation is your legal record of the trade.
Settlement follows. As of May 28, 2024, municipal securities settle on a T+1 cycle, meaning the transaction finalizes one business day after the trade date.8Investor.gov. New T+1 Settlement Cycle – What Investors Need To Know During that window your brokerage transfers funds to the issuer. Once settlement completes, the bonds appear in your account and start earning interest on the schedule set in the bond’s terms.
Buying on the Secondary Market
The secondary market is where you buy bonds that other investors already own. Search your brokerage platform by issuer, CUSIP, state, maturity, or rating. Each listing shows a bid/ask spread: the difference between the highest price a buyer is offering and the lowest price a seller will take. A market order buys immediately at the current ask; a limit order caps what you’re willing to pay.
You’ll also owe the seller accrued interest for the period since the bond’s last interest payment. Municipal bonds calculate accrued interest using a 30-day month and 360-day year convention.9MSRB. Rule G-33 Calculations If you buy 60 days after the last semiannual payment, you pay the seller for those 60 days, and you recover it when the next full interest payment arrives. Secondary trades also settle on a T+1 basis.10FINRA. Understanding Settlement Cycles – What Does T+1 Mean for You
Markups and Confirmation Disclosures
Dealers earn money in the secondary market through markups when selling to you, or markdowns when buying from you, rather than a separate commission. Under MSRB Rule G-30, the price a dealer charges must be fair and reasonable.11MSRB. Rule G-30 Prices and Commissions Since 2018, amended MSRB rules require dealers to disclose the markup on your trade confirmation as both a dollar amount and a percentage of the prevailing market price whenever the dealer also executed an offsetting trade on the same day.12Municipal Securities Rulemaking Board. Resource on Disclosing Mark-ups and Determining Prevailing Market Price The confirmation also includes the time of execution and a link to the bond’s EMMA page, where you can compare your price against recent trades of the same bond.
Time-of-Trade Information
Under MSRB Rule G-47, your broker must share all material information known about the bond at or before the time of trade. That includes facts a reasonable investor would consider important, such as whether the bond has call provisions, whether it prepays principal, and whether it carries market discount that could trigger ordinary income tax.
Confirm the Tax Treatment Before You Buy
The main draw of municipal bonds for many investors is the federal tax treatment. Under 26 U.S.C. § 103, interest earned on bonds issued by state and local governments is excluded from your gross income for federal tax purposes.1Office of the Law Revision Counsel. 26 U.S. Code 103 – Interest on State and Local Bonds In a high federal bracket, that exclusion can make the after-tax return competitive with, or better than, a higher-yielding taxable bond.
Not every municipal bond qualifies. Private activity bonds — those whose proceeds fund projects for private entities rather than the government itself — are taxable unless they meet specific exceptions in the tax code. Interest on certain private activity bonds is also a tax preference item under the Alternative Minimum Tax, so if you’re subject to the AMT you may owe tax on that interest even though it’s exempt under the regular income tax.13Office of the Law Revision Counsel. 26 U.S. Code 57 – Items of Tax Preference The Official Statement will say whether a bond is a private activity bond. Check it before you buy.
State taxes matter too. Most states exempt interest on bonds issued within your home state from state income tax but tax interest on out-of-state bonds. State rates range from zero up to over 13 percent, so out-of-state purchases eat into the overall tax advantage. If keeping the full benefit matters, limit purchases to bonds issued within your state.
One more tax trap on secondary purchases: if you buy at a discount and that discount exceeds 0.25 percent of face value for each full year remaining to maturity, the gain attributable to the discount is taxed as ordinary income rather than at the lower capital gains rate. Your broker must disclose at or before the time of trade that a bond carries market discount and that part of your return could be taxable as ordinary income.
You still report tax-exempt interest even though it isn’t taxed federally. Your broker sends a Form 1099-INT showing tax-exempt interest in box 8, which you report on line 2a of Form 1040; box 9 shows any private activity bond interest that may be subject to the AMT.14Internal Revenue Service. Instructions for Schedule B (Form 1040)
Risks Worth Checking Before You Click Buy
Municipal bonds are generally lower-risk, but they aren’t risk-free, and when you hold individual bonds directly you don’t have the diversification of a fund.
Interest Rate Risk
When market interest rates rise, the resale value of an existing bond typically falls, because a buyer can get a higher yield elsewhere. The longer the maturity, the more sensitive the price. A measure called duration estimates that sensitivity.15Municipal Securities Rulemaking Board. Evaluating a Municipal Bond’s Interest Rate Risk If you plan to hold to maturity, price swings along the way don’t affect your final payout. If you might need to sell early, they can mean receiving less than you paid.
Call Risk and Reinvestment Risk
Many municipal bonds are callable, meaning the issuer can pay them off early, usually when rates have fallen enough to make refinancing worthwhile. If your bond is called you receive the call price plus accrued interest, but the future interest payments you were counting on stop.16FINRA. Callable Bonds – Be Aware That Your Issuer May Come Calling Then comes reinvestment risk: because rates have likely dropped (which is why the issuer called), you may not find a comparable bond at the same yield. Check the call provisions in the Official Statement before you buy so this doesn’t surprise you.
Credit Risk
Credit risk is the possibility that the issuer can’t make interest or principal payments on time. Defaults among rated municipal issuers are rare, particularly for general obligation and essential-service revenue bonds, but they do occur, especially with unrated bonds or bonds tied to a single project’s revenue. Checking the rating and reading the financial disclosures on EMMA are the strongest tools you have to size up this risk before placing the order.