7631 / What does the holder of a Treasury note or bond include in annual income?

(1) Unless the note or bond was issued before March 1, 1941 (in which case it may be only partly taxable), stated interest that accrues after the date of purchase is included as ordinary income in the year in which it is received or made available (i.e., as a general rule, the date the coupon becomes due or the interest check is received).¹ If an individual purchased the bond between interest dates and paid the seller interest accrued but not yet due at the date of purchase, the individual does not deduct the amount or include it in basis; instead, the individual recovers that amount tax-free out of the first interest payment received and includes in income only the balance.²

(2) If the bond or note was originally issued at a discount (that is, at a price below the stated maturity or face amount) after July 1, 1982, any holder who did not pay more than the face value of the obligation must include in income each year a daily share of the “original issue discount” as discussed in Q 7650.(A discount of less than ¼ of 1 percent (.0025) times the number of years from issue to maturity may be disregarded. This is normally the case with Treasury notes and bonds.)³ The holder’s basis is increased by the amount of original issue discount (OID) actually included in income each year.⁴

However, if the obligation was originally issued before July 2, 1982, the amount of discount is not includable in income until it is received on sale or maturity of the obligation (see Q 7632).⁵

(3) Market discount accrued during the year on notes and bonds (acquired in tax years ending after July 18, 1984) must be included in income if an election to include market discount is in effect (see Q 7644).