7655 / How is the amount of amortizable bond premium determined?

The amortizable premium on taxable bonds acquired on or after January 1, 1958, is the excess of the individual’s tax basis for determining loss on sale or exchange of the bond (determined at the start of the year) over the amount payable at maturity, or in the case of a callable bond, the earlier call date if using the earlier call date would result in a smaller amortizable amount being allocated to the year.¹ It makes no difference whether the premium is original issue premium or “market” premium (generally reflecting a higher coupon interest rate on the bond than the market interest rate for bonds of similar quality). See Q 7659 in the case of a convertible bond with amortizable bond premium.

Under regulations generally in effect for bonds acquired on or after March 2, 1998, a holder acquires a bond at premium if the holder’s basis in the bond immediately after its acquisition by the holder exceeds the sum of all amounts payable on the bond after the acquisition date (other than payments of qualified stated interest); the excess is bond premium, which a holder amortizes.² Bond premium is allocable to an accrual period based on a constant yield that is used to conform the treatment of bond premium to the treatment of original issue discount (see Q 7650).³ Under a transition rule, the use of a constant yield to amortize premium does not apply to a bond issued before September 28, 1985.⁴ See Q 7654 for an explanation of the effective date of the regulations.

In general, the holder’s basis in the bond is the holder’s basis for purposes of determining loss on the sale or exchange of the bond. This determination of basis applies only for purposes of amortizing premium; a holder’s basis in the bond for purposes of amortizing premium may differ from the holder’s basis for purposes of determining gain or loss on the sale or exchange of the bond.⁵

For purposes of determining the amount amortizable, if the bond is acquired in an exchange for other property and the bond’s basis is determined (in whole or in part) by the basis of the property, the basis of the bond is not more than its fair market value immediately after the exchange.⁶ This rule applies to exchanges occurring after May 6, 1986.⁷ A special rule applies to a bond acquired in a bond-for-bond exchange in a corporate reorganization.⁸