Interest Is Income, Regardless of Rate Type
Bonds, promissory notes, and similar debt instruments are common trust investments. They generate two types of cash flow: periodic interest payments and the return of principal at maturity or sale. This statute draws a clear line between the two.
An amount received as interest, whether determined at a fixed, variable or floating rate, on an obligation to pay money to the trustee, including an amount received as consideration for prepaying principal, must be allocated to income without any provision for amortization of premium.
A.R.S. § 14-7415(A)All interest goes to income. It does not matter whether the rate is fixed, variable, or floating. Even prepayment consideration, which is essentially an early payoff penalty, gets classified as income. Notably, the statute eliminates premium amortization. If the trust purchased a bond at a premium, the trustee does not need to reduce income allocations to account for the premium gradually declining as the bond approaches maturity.
Sale Proceeds and the One-Year Rule
When the trustee sells, redeems, or otherwise disposes of a debt obligation that was held for more than one year, the proceeds go to principal. This applies even when the bond was purchased at a discount, meaning its purchase price was less than its face value at maturity.
A trustee shall allocate to principal an amount received from the sale, redemption or other disposition of an obligation to pay money to the trustee more than one year after it is purchased or acquired by the trustee, including an obligation whose purchase price or value when it is acquired is less than its value at maturity.
A.R.S. § 14-7415(B)There is one exception for short-term obligations. If the obligation matures within one year of purchase, any amount received above the purchase price goes to income rather than principal. This practical distinction recognizes that short-term instruments function more like cash equivalents than long-term investments. For trustees managing a bond portfolio or holding notes receivable, these rules determine how much flows to current beneficiaries versus how much stays in the trust's capital. Getting it right protects both sides. Experienced estate planning counsel can help structure these investments to align with the trust's distribution goals.
