7664 / Is premium paid for a tax-exempt bond deductible? Must basis in a tax-exempt bond be reduced by bond premium?

An individual who owns any fully tax-exempt interest bearing bond (or debenture, note, certificate, or other evidence of indebtedness) must amortize any premium paid for the bond, but the part of the premium allocable to the year is not deductible.¹ (The premium paid, in effect, reduces the annual interest; therefore, because the tax-free interest received each year represents in part a tax-free return of premium, the premium is not deductible.) Regulations in effect for bonds acquired before March 2, 1998 (or held before a taxable year containing March 2, 1998) provided substantially similar rules. See Q 7665 for an explanation of the effective date for final regulations under IRC Section 171. The individual must reduce his or her basis each year by the amount of premium allocable to the year.²

For an explanation of how the annual amount of amortization is calculated, see Q 7665.

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1.   IRC § 171; Treas. Reg. § 1.171-1(c).

2.   IRC § 1016(a)(5).

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