7641 / What is the coupon bond method that holders and issuers of inflation-adjusted debt instruments can use to account for interest and original issue discount?

The coupon bond method is a simplified version of the discount method (see Q 7642) that will apply if two conditions are satisfied: (1) the bond must be issued at par; and (2) all stated interest must be qualified stated interest.¹ A bond is issued at par if there is less than a de minimis difference between the bond’s issue price and its principal amount at issuance.² An amount is de minimis if it is equal to .0025 multiplied by the product of the stated redemption price at maturity and the number of complete years to maturity from the issue date.³ Qualified stated interest is stated interest that is unconditionally payable in cash, or is constructively received at least annually at a fixed rate.⁴ Any qualified stated interest is taken into account under the taxpayer’s regular method of accounting.⁵ Since Treasury Inflation-Protection Securities that are not stripped satisfy both of the above conditions, the coupon bond method applies to such securities.⁶

Under the coupon bond method, an inflation adjustment is taken into account for each taxable year in which the bond is outstanding in an amount equal to the sum of the inflation-adjusted principal amount at the end of the period and the principal payments made during the period minus the inflation-adjusted principal amount at the beginning of the period. A positive inflation adjustment will result in original issue discount while a negative inflation adjustment will be accounted for under the deflation adjustment rules (see Q 7640).⁷

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1.   Treas. Reg. § 1.1275-7(d)(2).

2.   Treas. Reg. § 1.1275-7(d)(2)(i).

3.   Treas. Reg. § 1.1273-1(d).