Tax Facts
7654 / Must premium paid on taxable bonds be amortized annually? Must basis be reduced by the amount of amortizable premium?
An individual who purchased a taxable bond at a premium (that is, at an amount in excess of its face value), whether or not on original issue, may elect to amortize the premium over the remaining life of the bond (or in some cases, until an earlier call date).1 If the election to amortize bond premium is not made, the premium is recovered as part of the owner’s basis in the bond, if the bond is sold for as much as or more than its cost, or is deducted as a capital loss if the bond is redeemed at face value or sold for less than the basis. See Q 7655 for an explanation of how the amount of amortizable bond premium is determined.
The election to amortize applies to all taxable bonds that are owned at the beginning of the first year to which the election applies and all bonds acquired thereafter, and may be revoked only with the consent of the Service.2 Under regulations generally in effect for bonds acquired on or after March 2, 1998, a revocation of the election applies to all taxable bonds held during or after the taxable year for which the revocation is effective, and the holder may not amortize any remaining bond premium on bonds held at the beginning of the taxable year for which the revocation is effective.3 See below for the effective date of the regulations.
The term “bond” to which the election applies includes any taxable bond, debenture, certificate, or other evidence of indebtedness issued by any corporation, government, or political subdivision.4 The taxpayer is not required to amortize premium on taxable bonds just because the taxpayer has tax-exempt bonds that he or she is amortizing.
For bonds acquired after December 31, 1987, an electing taxpayer applies the part of the premium attributable to the year as an offset to interest payments (that is, in direct reduction of interest income) received on the bond to which the premium is attributable.5
Taxpayers who elected to amortize premium on bonds acquired after October 22, 1986, and before January 1, 1988, could elect to use either the deduction or the offset method.6 These taxpayers treat the deduction as investment interest expense subject to the investment interest deduction limitations.7
With respect to bonds acquired before October 23, 1986, a taxpayer who elected to amortize takes an annual itemized interest expense deduction.8 The deduction is not subject to the 2 percent floor on miscellaneous deductions (all of which were suspended under the 2017 tax reform legislation for 2018-2025).9 Such an election to amortize in effect on October 22, 1986, does not apply to bonds acquired after October 22, 1986, unless the taxpayer so elected.10
Under regulations generally in effect for bonds acquired on or after March 2, 1998, a holder makes the election to amortize by offsetting interest income with bond premium in the holder’s timely filed federal income tax return for the first taxable year to which the holder desires the election to apply. A holder should also attach a statement to the return that he or she is making the election. See below for the effective date of the regulations. Regulations reflecting the law in effect prior to October 23, 1986, provided that the election was made by deducting the premium attributable to the year as an interest expense for the first year to which the election was to apply. The election to amortize could not be made in a refund claim.11
A bondholder making an election to treat all interest on a bond as original issue discount is deemed to have elected to amortize any existing bond premium (see Q 7650).12
If a bondholder elects to amortize bond premium and holds a taxable bond acquired before the taxable year for which the election is made, the holder may not amortize amounts that would have been amortized in prior taxable years had an election been in effect for those prior years.13
A taxpayer electing to amortize must also reduce basis in the bond by the amount of premium that is an allowable deduction or that was applied in reduction of interest payments each year.14
A bond with interest that is partially excludable from gross income is treated as two instruments, a tax-exempt obligation and a taxable bond. The holder’s bases in the bond and each payment on the bond are allocated between the two instruments based on a reasonable method.15 See Q 7664 and Q 7665 regarding the amortization of premium on tax-exempt bonds.
Regulations provide special rules that apply to certain variable rate debt instruments, bonds subject to certain contingencies, and inflation-indexed debt instruments.16
The regulations under IRC Section 171 do not apply to (1) a bond described in IRC Section 1272(a)(6)(C) (relating to regular interests in a REMIC, qualified mortgages held by a REMIC, and certain other debt instruments, or pools of debt instruments, with payments subject to acceleration); (2) a bond to which Treasury Regulation Section 1.1275-4 applies (relating to certain contingent pay debt instruments); (3) a bond held by a holder that elected to treat all interest on a debt instrument as original issue discount; (4) a bond that is stock in trade of the holder, a bond of a kind that would properly be included in the inventory of the holder if on hand at the close of the taxable year, or a bond held primarily for sale to customers in the ordinary course of the holder’s trade or business; or (5) a bond issued before September 28, 1985, unless the bond bears interest and was issued by a corporation or by a government or political subdivision thereof.17
Regulations generally in effect for bonds acquired before March 2, 1998 (or held before a taxable year containing March 2, 1998, in which an election to amortize was made) provided that, if in any year an individual who amortizes bond premium by deducting it as an interest expense does not itemize deductions, but takes a standard deduction, the deduction is deemed to have been allowed and reduces basis.18 Regulations also provided that an individual may, but need not, amortize premium in a year in which no interest is received.19 The regulations, as amended December 30, 1997, do not include the above rules.
Amortization of premium on tax-exempt bonds is discussed in Q 7664.
Effective date of regulations. The regulations under IRC Section 171 (as amended December 30, 1997) apply to bonds acquired on or after March 2, 1998. However, if a bondholder elected to amortize bond premium for the taxable year containing March 2, 1998, or any subsequent taxable year, the regulations under IRC Section 171 apply to bonds held on or after the first day of the taxable year in which the election was made.20
Furthermore, a holder was deemed to have made the election under regulations for the taxable year containing March 2, 1998, if the holder elected to amortize bond premium under IRC Section 171 and that election was effective on March 2, 1998. If the holder was deemed to have made such an election, the regulations under IRC Section 171 apply to bonds acquired on or after the first day of the taxable year containing March 2, 1998.21
Substitution of debt instruments. For the revised rules governing the treatment of bond premium when there is a substitution of newly issued bonds for outstanding bonds, see Revenue Procedure 2001-21.22
1. IRC § 171.
2. IRC § 171(c)(2); Treas. Reg. § 1.171-4.
3. Treas. Reg. § 1.171-4(d).
4. IRC § 171(d).
5. IRC § 171(e).
6. TAMRA ’88, § 1803(a)(11)(B).
7. IRC § 171(e), as in effect prior to amendment by TAMRA ’88, § 1006(j)(1).
8. IRC § 171(a).
9. IRC § 67(b)(11); see Conf. Report 99-841, Vol. II at page 34, 1986-3 CB Vol. 4.
10. TAMRA ’88, Act § 1006(j)(2).
11. Woodward Est. v. Comm., 24 TC 883 (1955) aff’d sub. nom. Barnhill v. Comm., 241 F.2d 496 (5th Cir. 1957), acq., 1956-2 CB 4, 1956-2 CB 9.
12. Treas. Reg. § 1.171-4(a)(2).
13. Treas. Reg. § 1.171-4(c).
14. IRC § 1016(a)(5); Treas. Reg. § 1.1016-5(b).
15. Treas. Reg. § 1.171-1(c)(3).
16. Treas. Reg. § 1.171-3.
17. Treas. Reg. § 1.171-1(b)(2).
18. Treas. Reg. § 1.171-1(b)(5).
19. Treas. Reg. § 1.171-2(e).
20. Treas. Reg. § 1.171-5(a).
21. Treas. Reg. § 1.171-5(b).
22. 2001-1 CB 742.
The election to amortize applies to all taxable bonds that are owned at the beginning of the first year to which the election applies and all bonds acquired thereafter, and may be revoked only with the consent of the Service.2 Under regulations generally in effect for bonds acquired on or after March 2, 1998, a revocation of the election applies to all taxable bonds held during or after the taxable year for which the revocation is effective, and the holder may not amortize any remaining bond premium on bonds held at the beginning of the taxable year for which the revocation is effective.3 See below for the effective date of the regulations.
The term “bond” to which the election applies includes any taxable bond, debenture, certificate, or other evidence of indebtedness issued by any corporation, government, or political subdivision.4 The taxpayer is not required to amortize premium on taxable bonds just because the taxpayer has tax-exempt bonds that he or she is amortizing.
For bonds acquired after December 31, 1987, an electing taxpayer applies the part of the premium attributable to the year as an offset to interest payments (that is, in direct reduction of interest income) received on the bond to which the premium is attributable.5
Taxpayers who elected to amortize premium on bonds acquired after October 22, 1986, and before January 1, 1988, could elect to use either the deduction or the offset method.6 These taxpayers treat the deduction as investment interest expense subject to the investment interest deduction limitations.7
With respect to bonds acquired before October 23, 1986, a taxpayer who elected to amortize takes an annual itemized interest expense deduction.8 The deduction is not subject to the 2 percent floor on miscellaneous deductions (all of which were suspended under the 2017 tax reform legislation for 2018-2025).9 Such an election to amortize in effect on October 22, 1986, does not apply to bonds acquired after October 22, 1986, unless the taxpayer so elected.10
Under regulations generally in effect for bonds acquired on or after March 2, 1998, a holder makes the election to amortize by offsetting interest income with bond premium in the holder’s timely filed federal income tax return for the first taxable year to which the holder desires the election to apply. A holder should also attach a statement to the return that he or she is making the election. See below for the effective date of the regulations. Regulations reflecting the law in effect prior to October 23, 1986, provided that the election was made by deducting the premium attributable to the year as an interest expense for the first year to which the election was to apply. The election to amortize could not be made in a refund claim.11
A bondholder making an election to treat all interest on a bond as original issue discount is deemed to have elected to amortize any existing bond premium (see Q 7650).12
If a bondholder elects to amortize bond premium and holds a taxable bond acquired before the taxable year for which the election is made, the holder may not amortize amounts that would have been amortized in prior taxable years had an election been in effect for those prior years.13
A taxpayer electing to amortize must also reduce basis in the bond by the amount of premium that is an allowable deduction or that was applied in reduction of interest payments each year.14
A bond with interest that is partially excludable from gross income is treated as two instruments, a tax-exempt obligation and a taxable bond. The holder’s bases in the bond and each payment on the bond are allocated between the two instruments based on a reasonable method.15 See Q 7664 and Q 7665 regarding the amortization of premium on tax-exempt bonds.
Regulations provide special rules that apply to certain variable rate debt instruments, bonds subject to certain contingencies, and inflation-indexed debt instruments.16
The regulations under IRC Section 171 do not apply to (1) a bond described in IRC Section 1272(a)(6)(C) (relating to regular interests in a REMIC, qualified mortgages held by a REMIC, and certain other debt instruments, or pools of debt instruments, with payments subject to acceleration); (2) a bond to which Treasury Regulation Section 1.1275-4 applies (relating to certain contingent pay debt instruments); (3) a bond held by a holder that elected to treat all interest on a debt instrument as original issue discount; (4) a bond that is stock in trade of the holder, a bond of a kind that would properly be included in the inventory of the holder if on hand at the close of the taxable year, or a bond held primarily for sale to customers in the ordinary course of the holder’s trade or business; or (5) a bond issued before September 28, 1985, unless the bond bears interest and was issued by a corporation or by a government or political subdivision thereof.17
Regulations generally in effect for bonds acquired before March 2, 1998 (or held before a taxable year containing March 2, 1998, in which an election to amortize was made) provided that, if in any year an individual who amortizes bond premium by deducting it as an interest expense does not itemize deductions, but takes a standard deduction, the deduction is deemed to have been allowed and reduces basis.18 Regulations also provided that an individual may, but need not, amortize premium in a year in which no interest is received.19 The regulations, as amended December 30, 1997, do not include the above rules.
Amortization of premium on tax-exempt bonds is discussed in Q 7664.
Effective date of regulations. The regulations under IRC Section 171 (as amended December 30, 1997) apply to bonds acquired on or after March 2, 1998. However, if a bondholder elected to amortize bond premium for the taxable year containing March 2, 1998, or any subsequent taxable year, the regulations under IRC Section 171 apply to bonds held on or after the first day of the taxable year in which the election was made.20
Furthermore, a holder was deemed to have made the election under regulations for the taxable year containing March 2, 1998, if the holder elected to amortize bond premium under IRC Section 171 and that election was effective on March 2, 1998. If the holder was deemed to have made such an election, the regulations under IRC Section 171 apply to bonds acquired on or after the first day of the taxable year containing March 2, 1998.21
Substitution of debt instruments. For the revised rules governing the treatment of bond premium when there is a substitution of newly issued bonds for outstanding bonds, see Revenue Procedure 2001-21.22
1. IRC § 171.
2. IRC § 171(c)(2); Treas. Reg. § 1.171-4.
3. Treas. Reg. § 1.171-4(d).
4. IRC § 171(d).
5. IRC § 171(e).
6. TAMRA ’88, § 1803(a)(11)(B).
7. IRC § 171(e), as in effect prior to amendment by TAMRA ’88, § 1006(j)(1).
8. IRC § 171(a).
9. IRC § 67(b)(11); see Conf. Report 99-841, Vol. II at page 34, 1986-3 CB Vol. 4.
10. TAMRA ’88, Act § 1006(j)(2).
11. Woodward Est. v. Comm., 24 TC 883 (1955) aff’d sub. nom. Barnhill v. Comm., 241 F.2d 496 (5th Cir. 1957), acq., 1956-2 CB 4, 1956-2 CB 9.
12. Treas. Reg. § 1.171-4(a)(2).
13. Treas. Reg. § 1.171-4(c).
14. IRC § 1016(a)(5); Treas. Reg. § 1.1016-5(b).
15. Treas. Reg. § 1.171-1(c)(3).
16. Treas. Reg. § 1.171-3.
17. Treas. Reg. § 1.171-1(b)(2).
18. Treas. Reg. § 1.171-1(b)(5).
19. Treas. Reg. § 1.171-2(e).
20. Treas. Reg. § 1.171-5(a).
21. Treas. Reg. § 1.171-5(b).
22. 2001-1 CB 742.
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