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