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. That is, the loss can fully offset gains. Then, up to $3,000 of losses can be used to offset ordinary income ($1,500 for those who are married filing separately). Any excess capital loss can be carried forward to the following year.
Items directly reducing income. Personal deductions such as for mortgage interest, state and local taxes, and charitable contributions are allowed only if deductions are itemized on Schedule A, but deductions such as for alimony, capital losses, moving expenses to a new job location, business losses, student loan interest, and IRA and Keogh deductions are deducted from gross income even if itemized deductions are not claimed.