X Corp issues a bond on March 1, 2014 with a maturity date of February 28, 2024. The issue price and redemption amount is 100,000. The bonds have a 5% coupon. On March 1, 2019, C purchases the bond with a redemption amount of $10,000 for $1,000. The drop in price is due solely to the deterioration of X Corp’s credit rating. C sells the bond on March 2, 2021 for $2,500 and claims that the entire gain is long term capital gain.
Assume you are representing the client with respect to his audit by the IRS and the IRS is claiming that the $2,500 is not capital gain. What convincing argument can you make that the gain should be treated as capital?