7656 / How is the bond premium allocable to an accrual period calculated if the bond was issued on or after September 28, 1985?

Step one: Determine the holder’s yield. The holder’s yield is the discount rate that, when used in computing the present value of all remaining payments to be made on the bond (including payments of qualified stated interest), produces an amount equal to the holder’s basis in the bond. The remaining payments include only payments to be made after the date the holder acquires the bond. The yield calculated as of the date the holder acquires the bond must be constant over the term of the bond, and must be calculated to at least two decimal places when expressed as a percentage.¹

Step two: Determine the accrual periods. An accrual period is an interval of time over which the accrual of bond premium is measured. Accrual periods may be of any length over the term of the debt instrument, provided that each accrual period is no longer than one year and each scheduled payment occurs on the final day of an accrual period or on the first day of an accrual period.²

Step three: Determine the bond premium allocable to the accrual period. The bond premium allocable to an accrual period is the excess of the qualified stated interest allocable to the accrual period over the product of the holder’s adjusted acquisition price at the beginning of the accrual period and the holder’s yield. In performing this calculation, the yield must be stated appropriately taking into account the length of the particular accrual period.³ The adjusted acquisition price of a bond at the beginning of the first accrual period is the holder’s basis (see below). Thereafter, the adjusted acquisition price is the holder’s basis in the bond decreased by (1) the amount of bond premium previously allocable (as calculated above), and (2) the amount of any payment previously made on the bond other than the payment of qualified stated interest.