Bond Premium

<div class="Section1">The Service will disallow amortization in situations that lack economic substance.<a href="#_ftn1" name="_ftnref1">¹</a> A deduction for amortization was disallowed where sales were not bona fide sales;<a href="#_ftn2" name="_ftnref2">²</a> and where an individual who put up no margin, signed no note, and intended to sell the bonds to cover his liability, was ruled not to be the owner of the bonds for purposes of deducting a part of the premium.<a href="#_ftn3" name="_ftnref3">³</a><div class="Section1"><br /> <br /> Amortization of premium on tax-exempt bonds is discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7664">7664</a>.<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp; Rev. Rul. 62-127, 1962-2 CB 84. With the 2010 codification of the economic substance doctrine, <em><em>see</em></em> IRC &sect;&nbsp;7701(o), many transactions must pass scrutiny under this doctrine to be honored.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp; <em>Lieb v. Comm.</em>, 40 TC 161 (1963).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp; <em>Starr v. Comm.</em>, 46 TC 450 (1966), <em>acq.</em> 1967-2 CB 3.7.<br /> <br /> </div></div><br />

<div class="Section1">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 <em>elect</em> to amortize the premium over the remaining life of the bond (or in some cases, until an earlier call date).<a href="#_ftn1" name="_ftnref1">¹</a> If the election to amortize bond premium is not made, the premium is recovered as part of the owner&rsquo;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. <em><em>See</em> </em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7655">7655</a> for an explanation of how the amount of amortizable bond premium is determined.<div class="Section1"><br /> <br /> 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.<a href="#_ftn2" name="_ftnref2">²</a> Under regulations generally in effect for bonds acquired on or after March&nbsp;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.<a href="#_ftn3" name="_ftnref3">³</a> <em><em>See</em> </em>below for the effective date of the regulations.<br /> <br /> The term &ldquo;bond&rdquo; to which the election applies includes any taxable bond, debenture, certificate, or other evidence of indebtedness issued by any corporation, government, or political subdivision.<a href="#_ftn4" name="_ftnref4">⁴</a> The taxpayer is not required to amortize premium on taxable bonds just because the taxpayer has <em>tax-exempt</em> bonds that he or she is amortizing.<br /> <br /> For bonds acquired after December&nbsp;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.<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <br /> Taxpayers who elected to amortize premium on bonds acquired after October&nbsp;22, 1986, and before January&nbsp;1, 1988, could elect to use either the deduction or the offset method.<a href="#_ftn6" name="_ftnref6">⁶</a> These taxpayers treat the deduction as investment interest expense subject to the investment interest deduction limitations.<a href="#_ftn7" name="_ftnref7">⁷</a><br /> <br /> With respect to bonds acquired before October 23, 1986, a taxpayer who elected to amortize takes an annual itemized interest expense deduction.<a href="#_ftn8" name="_ftnref8">⁸</a> The deduction is not subject to the 2&nbsp;percent floor on miscellaneous deductions (all of which were suspended under the 2017 tax reform legislation for 2018-2025).<a href="#_ftn9" name="_ftnref9">⁹</a> Such an election to amortize in effect on October&nbsp;22, 1986, does not apply to bonds acquired after October&nbsp;22, 1986, unless the taxpayer so elected.<a href="#_ftn10" name="_ftnref10">¹⁰</a><br /> <br /> Under regulations generally in effect for bonds acquired on or after March&nbsp;2, 1998, a holder makes the election to amortize by offsetting interest income with bond premium in the holder&rsquo;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. <em><em>See</em> </em>below for the effective date of the regulations. Regulations reflecting the law in effect prior to October&nbsp;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.<a href="#_ftn11" name="_ftnref11">¹¹</a><br /> <br /> 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 (<em><em>see</em> </em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7650">7650</a>).<a href="#_ftn12" name="_ftnref12">¹²</a><br /> <br /> 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.<a href="#_ftn13" name="_ftnref13">¹³</a><br /> <br /> 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.<a href="#_ftn14" name="_ftnref14">¹⁴</a><br /> <br /> 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&rsquo;s bases in the bond and each payment on the bond are allocated between the two instruments based on a reasonable method.<a href="#_ftn15" name="_ftnref15">¹⁵</a> <em><em>See</em> </em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7664">7664</a> and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7665">7665</a> regarding the amortization of premium on tax-exempt bonds.<br /> <br /> Regulations provide special rules that apply to certain variable rate debt instruments, bonds subject to certain contingencies, and inflation-indexed debt instruments.<a href="#_ftn16" name="_ftnref16">¹⁶</a><br /> <br /> The regulations under IRC Section&nbsp;171 do not apply to (1) a bond described in IRC Section&nbsp;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&nbsp;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&rsquo;s trade or business; or (5) a bond issued before September&nbsp;28, 1985, unless the bond bears interest and was issued by a corporation or by a government or political subdivision thereof.<a href="#_ftn17" name="_ftnref17">¹⁷</a><br /> <br /> Regulations generally in effect for bonds acquired before March&nbsp;2, 1998 (or held before a taxable year containing March&nbsp;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.<a href="#_ftn18" name="_ftnref18">¹⁸</a> Regulations also provided that an individual may, but need not, amortize premium in a year in which no interest is received.<a href="#_ftn19" name="_ftnref19">¹⁹</a> The regulations, as amended December&nbsp;30, 1997, do not include the above rules.<br /> <br /> Amortization of premium on tax-exempt bonds is discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7664">7664</a>.<br /> <br /> <em>Effective date of regulations</em>. The regulations under IRC Section&nbsp;171 (as amended December&nbsp;30, 1997) apply to bonds acquired on or after March&nbsp;2, 1998. However, if a bondholder elected to amortize bond premium for the taxable year containing March&nbsp;2, 1998, or any subsequent taxable year, the regulations under IRC Section&nbsp;171 apply to bonds held on or after the first day of the taxable year in which the election was made.<a href="#_ftn20" name="_ftnref20">²⁰</a><br /> <br /> Furthermore, a holder was deemed to have made the election under regulations for the taxable year containing March&nbsp;2, 1998, if the holder elected to amortize bond premium under IRC Section&nbsp;171 and that election was effective on March&nbsp;2, 1998. If the holder was deemed to have made such an election, the regulations under IRC Section&nbsp;171 apply to bonds acquired on or after the first day of the taxable year containing March&nbsp;2, 1998.<a href="#_ftn21" name="_ftnref21">²¹</a><br /> <br /> <em>Substitution of debt instruments</em>. For the revised rules governing the treatment of bond premium when there is a substitution of newly issued bonds for outstanding bonds, <em><em>see</em> </em>Revenue Procedure 2001-21.<a href="#_ftn22" name="_ftnref22">²²</a><br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp; IRC &sect;&nbsp;171.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp; IRC &sect;&nbsp;171(c)(2); Treas. Reg. &sect;&nbsp;1.171-4.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.171-4(d).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp;&nbsp; IRC &sect;&nbsp;171(d).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.&nbsp;&nbsp; IRC &sect;&nbsp;171(e).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>.&nbsp;&nbsp; TAMRA &rsquo;88, &sect;&nbsp;1803(a)(11)(B).<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>.&nbsp;&nbsp; IRC &sect;&nbsp;171(e), as in effect prior to amendment by TAMRA &rsquo;88, &sect;&nbsp;1006(j)(1).<br /> <br /> <a href="#_ftnref8" name="_ftn8">8</a>.&nbsp;&nbsp; IRC &sect;&nbsp;171(a).<br /> <br /> <a href="#_ftnref9" name="_ftn9">9</a>.&nbsp;&nbsp; IRC &sect;&nbsp;67(b)(11); <em><em>see</em></em> Conf. Report 99-841, Vol. II at page 34, 1986-3 CB Vol. 4.<br /> <br /> <a href="#_ftnref10" name="_ftn10">10</a>.&nbsp;&nbsp; TAMRA &rsquo;88, Act &sect;&nbsp;1006(j)(2).<br /> <br /> <a href="#_ftnref11" name="_ftn11">11</a>.&nbsp;&nbsp; <em>Woodward Est. v. Comm.</em>, 24 TC 883 (1955) <em>aff&rsquo;d sub. nom. Barnhill v. Comm.</em>, 241 F.2d 496 (5th Cir. 1957), <em>acq</em>., 1956-2 CB 4, 1956-2 CB 9.<br /> <br /> <a href="#_ftnref12" name="_ftn12">12</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.171-4(a)(2).<br /> <br /> <a href="#_ftnref13" name="_ftn13">13</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.171-4(c).<br /> <br /> <a href="#_ftnref14" name="_ftn14">14</a>.&nbsp;&nbsp; IRC &sect;&nbsp;1016(a)(5); Treas. Reg. &sect;&nbsp;1.1016-5(b).<br /> <br /> <a href="#_ftnref15" name="_ftn15">15</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.171-1(c)(3).<br /> <br /> <a href="#_ftnref16" name="_ftn16">16</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.171-3.<br /> <br /> <a href="#_ftnref17" name="_ftn17">17</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.171-1(b)(2).<br /> <br /> <a href="#_ftnref18" name="_ftn18">18</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.171-1(b)(5).<br /> <br /> <a href="#_ftnref19" name="_ftn19">19</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.171-2(e).<br /> <br /> <a href="#_ftnref20" name="_ftn20">20</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.171-5(a).<br /> <br /> <a href="#_ftnref21" name="_ftn21">21</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.171-5(b).<br /> <br /> <a href="#_ftnref22" name="_ftn22">22</a>.&nbsp;&nbsp; 2001-1 CB 742.<br /> <br /> </div></div><br />

<div class="Section1">The bond premium allocable to an accrual period is calculated using the following three steps.<div class="Section1"><br /> <br /> <em>Step one: Determine the holder&rsquo;s yield.</em> The holder&rsquo;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&rsquo;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&nbsp;percentage.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> <em>Step two: Determine the accrual periods.</em> 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.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> <em>Step three: Determine the bond premium allocable to the accrual period.</em> 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&rsquo;s <em>adjusted acquisition price</em> at the beginning of the accrual period and the holder&rsquo;s yield. In performing this calculation, the yield must be stated appropriately taking into account the length of the particular accrual period.<a href="#_ftn3" name="_ftnref3">³</a> The <em>adjusted acquisition price</em> of a bond at the beginning of the first accrual period is the holder&rsquo;s basis (<em><em>see</em> </em>below). Thereafter, the adjusted acquisition price is the holder&rsquo;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.<br /> <br /> If the bond premium allocable to an accrual period exceeds the qualified stated interest allocable to the accrual period, the excess is treated by the holder as a bond premium deduction for the accrual period. However, the amount treated as a bond premium deduction is limited to the amount by which the holder&rsquo;s total interest inclusions on the bond in prior accrual periods exceeds the total amount treated by the holder as a bond premium deduction on the bond in prior accrual periods. A deduction determined under this rule is not subject to the 2&nbsp;percent floor on miscellaneous itemized deductions (although these deductions were suspended for 2018-2025).<a href="#_ftn4" name="_ftnref4">⁴</a> If the bond premium allocable to an accrual period exceeds the sum of the qualified stated interest allocable to the accrual period and the amount treated as a deduction for the accrual period, the excess is carried forward to the next accrual period and is treated as bond premium allocable to that period.<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <br /> For bonds acquired on or after January&nbsp;1, 2013, if there is such a bond premium carryforward as of the end of the holder&rsquo;s accrual period in which the bond is sold, retired, or otherwise disposed of, the holder treats the amount of the carryforward as a bond premium deduction under Section&nbsp;171(a)(1) for the year in which such disposition occurs.<a href="#_ftn6" name="_ftnref6">⁶</a><br /> <br /> Additional rules apply to determine the amortization of bond premium on a variable rate debt instrument, an inflation-indexed debt instrument, a bond that provides for certain alternative payment schedules, and a bond that provides for remote or incidental contingencies.<a href="#_ftn7" name="_ftnref7">⁷</a><br /> <br /> The regulations are generally effective for bonds acquired after March&nbsp;2, 1998, but certain transition rules may have applied (<em><em>see</em> </em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7654">7654</a>).<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.171-2(a)(3)(i).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp; Treas. Reg. &sect;&sect;&nbsp;1.171-2(a)(3)(ii), 1.1272-1(b)(1)(ii).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.171-2(a)(3)(iii).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.171-2(a)(4)(i)(A).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.171-2(a)(4)(i)(B).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.171-2(a)(4)(i)(C).<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.171-3.<br /> <br /> </div></div><br />

<div class="Section1">The amortizable premium on taxable bonds acquired on or after January&nbsp;1, 1958, is the excess of the individual&rsquo;s tax basis for determining <em>loss</em> 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.<a href="#_ftn1" name="_ftnref1">¹</a> It makes no difference whether the premium is original issue premium or &ldquo;market&rdquo; premium (generally reflecting a higher coupon interest rate on the bond than the market interest rate for bonds of similar quality). <em><em>See</em> </em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7659">7659</a> in the case of a convertible bond with amortizable bond premium.<div class="Section1"><br /> <br /> Under regulations generally in effect for bonds acquired on or after March&nbsp;2, 1998, a holder acquires a bond at premium if the holder&rsquo;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.<a href="#_ftn2" name="_ftnref2">²</a> 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 (<em><em>see</em> </em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7650">7650</a>).<a href="#_ftn3" name="_ftnref3">³</a> Under a transition rule, the use of a constant yield to amortize premium does not apply to a bond issued before September&nbsp;28, 1985.<a href="#_ftn4" name="_ftnref4">⁴</a> <em><em>See</em> </em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7654">7654</a> for an explanation of the effective date of the regulations.<br /> <br /> In general, the holder&rsquo;s basis in the bond is the holder&rsquo;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&rsquo;s basis in the bond for purposes of amortizing premium may differ from the holder&rsquo;s basis for purposes of determining gain or loss on the sale or exchange of the bond.<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <br /> For purposes of determining the amount amortizable, if the bond is acquired in an exchange for other property and the bond&rsquo;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.<a href="#_ftn6" name="_ftnref6">⁶</a> This rule applies to exchanges occurring after May&nbsp;6, 1986.<a href="#_ftn7" name="_ftnref7">⁷</a> A special rule applies to a bond acquired in a bond-for-bond exchange in a corporate reorganization.<a href="#_ftn8" name="_ftnref8">⁸</a><br /> <br /> If the bond is <em>transferred basis property</em> and the transferor had acquired the bond at a premium, the holder&rsquo;s basis in the bond is the holder&rsquo;s basis for determining loss on the sale or exchange of the bond reduced by any amounts that the transferor could not have amortized (under the basis rules or because of an election to amortize in a subsequent taxable year), except to the extent that the holder&rsquo;s basis already reflects a reduction attributable to the nonamortizable amounts.<a href="#_ftn9" name="_ftnref9">⁹</a> <em>Transferred basis property</em> is property having a basis determined in whole or in part by the basis of the transferor.<a href="#_ftn10" name="_ftnref10">¹⁰</a><br /> <br /> For a detailed explanation of the effective dates for the regulations under IRC Section&nbsp;171, <em><em>see</em> </em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7654">7654</a>.<br /> <p style="text-align: center;"><strong>Calculation of Annual Deduction or Offset</strong></p><br /> <p style="text-align: center;"><strong>Bonds Issued After September&nbsp;27, 1985</strong></p><br /> Except as provided in regulations (<em><em>see</em> </em>below), the determination of the amount of the deduction or offset in any year is computed on the basis of the taxpayer&rsquo;s yield to maturity by using the taxpayer&rsquo;s basis in the bond (for purposes of determining loss) and by compounding at the close of each accrual period. Generally, an accrual period is the same as used in determining original issue discount (<em><em>see</em> </em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7650">7650</a>). If the amount payable on a call date that is earlier than maturity is used for purposes of determining the yield to maturity, the bond is treated as maturing on the call date and then as reissued on that call date for the amount payable on the call date.<a href="#_ftn11" name="_ftnref11">¹¹</a> If a taxpayer had an election to amortize bond premium in effect on October&nbsp;22, 1986, the election applies to bonds issued after September&nbsp;27, 1985, only if the taxpayer so chooses (as may be prescribed in regulations).<a href="#_ftn12" name="_ftnref12">¹²</a><br /> <br /> Under regulations generally in effect for bonds acquired on or after March&nbsp;2, 1998, a holder amortizes bond premium by offsetting the qualified stated interest allocable to an accrual period with the bond premium allocable to the accrual period (<em><em>see</em> </em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7656">7656</a>). This offset occurs when the holder takes the qualified stated interest into account under the holder&rsquo;s regular method of accounting.<a href="#_ftn13" name="_ftnref13">¹³</a> The accrual period to which qualified stated interest is allocable is determined under the regulations to IRC Section&nbsp;446 (relating to the general rule for methods of accounting).<a href="#_ftn14" name="_ftnref14">¹⁴</a> For a detailed explanation of the effective date of the regulations, <em><em>see</em> </em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7654">7654</a>.<br /> <p style="text-align: center;"><strong>Bonds Issued On or Before September&nbsp;27, 1985</strong></p><br /> The amount of the deduction or offset each year may be determined under any reasonable method of amortization, but once an individual has used a method, the individual must consistently use the same method. (The Service has approved use of the &ldquo;yield&rdquo; method of amortizing bond premium.)<a href="#_ftn15" name="_ftnref15">¹⁵</a> Instead of any other method, he or she may use the straight line method set forth in regulations (in effect for bonds acquired before March&nbsp;2, 1998, or held before a taxable year containing March&nbsp;2, 1998). Under that method, the amount of premium that is deductible or offset each year is an amount that bears the same ratio to the bond premium as the number of months in the tax year the bond was held by the individual bears to the number of months from the beginning of the tax year (or, if the bond was acquired in the tax year, from the date of acquisition) to the date of maturity or to an earlier call date if appropriate. A fractional part of a month is counted only if it is more than one-half of a month and then it is counted as a month.<a href="#_ftn16" name="_ftnref16">¹⁶</a> The additional regulations, amended December&nbsp;30, 1997, do not include the above rules.<br /> <br /> Under regulations in effect for bonds acquired before March&nbsp;2, 1998 (or held before a taxable year containing March&nbsp;2, 1998), if the premium is solely a result of capitalized expenses (such as buying commissions), an individual using the straight line method provided in the regulations may amortize the capital expenses. If such expenses are a part of a larger premium, the individual must treat them as part of the premium if he or she uses the straight line method.<a href="#_ftn17" name="_ftnref17">¹⁷</a> The regulations, as amended December&nbsp;30, 1997, do not include the above rule.<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp; IRC &sect;&nbsp;171(b).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.171-1(d).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.171-1(a).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.171-5(a)(2).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.171-1(e).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>.&nbsp;&nbsp; IRC &sect;&nbsp;171(b)(4); Treas. Reg. &sect;&nbsp;1.171-1(e)(1)(ii).<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>.&nbsp;&nbsp; TRA &rsquo;86, &sect;&nbsp;1803(a)(12)(A).<br /> <br /> <a href="#_ftnref8" name="_ftn8">8</a>.&nbsp;&nbsp; IRC &sect;&nbsp;171(b)(4)(B).<br /> <br /> <a href="#_ftnref9" name="_ftn9">9</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.171-1(e)(2).<br /> <br /> <a href="#_ftnref10" name="_ftn10">10</a>.&nbsp;&nbsp; IRC &sect;&nbsp;7701(a)(43).<br /> <br /> <a href="#_ftnref11" name="_ftn11">11</a>.&nbsp;&nbsp; IRC &sect;&nbsp;171(b)(3).<br /> <br /> <a href="#_ftnref12" name="_ftn12">12</a>.&nbsp;&nbsp; TRA &rsquo;86, &sect;&nbsp;1803(a)(11)(A).<br /> <br /> <a href="#_ftnref13" name="_ftn13">13</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.171-2(a)(1).<br /> <br /> <a href="#_ftnref14" name="_ftn14">14</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.171-2(a)(2).<br /> <br /> <a href="#_ftnref15" name="_ftn15">15</a>.&nbsp;&nbsp; Rev. Rul. 82-10, 1982-1 CB 46.<br /> <br /> <a href="#_ftnref16" name="_ftn16">16</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.171-2(f).<br /> <br /> <a href="#_ftnref17" name="_ftn17">17</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.171-2(d).<br /> <br /> </div></div><br />

<div class="Section1">The amount of amortizable bond premium on a convertible bond may not include any amount attributable to the bond&rsquo;s conversion features.<a href="#_ftn1" name="_ftnref1">¹</a> Under regulations generally in effect for bonds acquired on or after March&nbsp;2, 1998 (<em><em>see</em> </em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7654">7654</a>), the holder&rsquo;s basis in the bond is reduced by an amount equal to the value of the conversion option. The value of the conversion option may be determined under any reasonable method. For example, the holder may determine the value of the conversion option by comparing the market price of the convertible bond to the market prices of similar bonds that do not have conversion options.<a href="#_ftn2" name="_ftnref2">²</a><div class="Section1"><br /> <br /> On January&nbsp;1, 2025, John Smith purchases for $1,100 a convertible bond maturing on January&nbsp;1, 2028, with a stated principal amount of $1,000, payable at maturity. The bond provides for unconditional payments of interest of $20.00 on January&nbsp;1 and July&nbsp;1 of each year. In addition, the bond is convertible into 15 shares of the corporation&rsquo;s stock at the option of the holder. On January&nbsp;1, 2025, the corporation&rsquo;s nonconvertible, publicly-traded, three-year debt with a similar credit rating trades at a price that reflects a yield of 4.50&nbsp;percent, compounded semiannually.<br /> <br /> Mr. Smith&rsquo;s basis for determining loss on the sale or exchange of the bond is $1,100. As of January&nbsp;1, 2025, discounting the remaining payments on the bond at the yield at which the corporation&rsquo;s similar nonconvertible bonds trade (4.50&nbsp;percent, compounded semiannually) results in a present value of $985. Thus, the value of the conversion option is $115. Mr. Smith&rsquo;s basis is $985 ($1,100 - $115) for purposes of the rules and regulations of IRC Section&nbsp;171. The sum of all amounts payable on the bond other than qualified stated interest is $1,000. Because Mr. Smith&rsquo;s basis (under IRC Section&nbsp;171) does not exceed $1,000, he does not acquire the bond at a premium.<br /> <br /> Regulations in effect for bonds acquired before March&nbsp;2, 1998 (or held before a taxable year containing March&nbsp;2, 1998) provided that the value of the conversion features is determined as of the date of acquisition by adjusting the price of the bond to a yield determined by comparison with the yields of bonds of similar character without conversion features that are sold on the open market.<a href="#_ftn3" name="_ftnref3">³</a> The above language is not included in the regulations, as amended December&nbsp;31, 1997.<br /> <br /> Under the regulations, if a convertible bond is acquired in exchange for other property and the holder&rsquo;s basis in the bond is determined in whole or in part by reference to the holder&rsquo;s basis in the other property, the holder&rsquo;s basis in the bond may not exceed its fair market value immediately after the exchange reduced by the value of the conversion option.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> The amount of premium amortizable in a year is discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7655">7655</a>. The tax treatment of the amount is explained in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7654">7654</a>.<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp; IRC &sect;&nbsp;171(b)(1).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.171-1(e)(1)(iii).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.171-2(c)(2).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.171-1(e)(iii)(B).<br /> <br /> </div></div><br />

<div class="Section1">If the bond is called before maturity, the amount of premium amortizable in that year is the excess of adjusted basis for determining loss over the greater of the amount received on call or the amount payable on maturity.<a href="#_ftn1" name="_ftnref1">¹</a></div><br /> <div class="Section1"><br /> <br /> Under regulations in effect for bonds acquired before March 2, 1998 (or held before a taxable year containing March 2, 1998), the earlier call date (if it is used to determine amortizable premium) may be the earliest call date specified in the bond as a day certain, the earliest interest payment date if the bond is callable at such date, the earliest date at which the bond is callable at par, or such other call date, prior to maturity, specified in the bond as may be selected by the taxpayer.<a href="#_ftn2" name="_ftnref2">²</a> Where amortization is determined with respect to one of the alternative call dates, if in fact the bond is not called on that date, the premium must be amortized to a succeeding date or to maturity. The additional final regulations, amended December 30, 1997, do not include the above rules.<br /> <p style="text-align: center;"><strong>Basis Adjustment</strong></p><br /> Regulations in effect for bonds acquired before March 2, 1998 (or held before a taxable year containing March 2, 1998) provided that, in determining the amount of premium to be amortized each year, the basis was adjusted for amortizable premium previously deducted or offset.<a href="#_ftn3" name="_ftnref3">³</a> Also, an adjustment had to be made for premium not amortized in years the individual held the bond before he or she elected to amortize. However, this adjustment was made only for the purpose of determining the amortizable amount; the amount not amortized before the election did not affect basis for determining gain or loss on sale or exchange.<a href="#_ftn4" name="_ftnref4">⁴</a> If the bond was acquired by gift (or the individual’s basis is for some other reason determined by reference to the basis in the hands of another), the same adjustment must include the period the bond was held by the other person. The regulations, as amended December 30, 1997, do not include the above rules.<br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.   IRC § 171(b)(2).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.   Treas. Reg. § 1.171-2(b).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.   Treas. Reg. § 1.171-2(f)(2)(ii).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.   Treas. Reg. § 1.171-2(a)(4).<br /> <br /> </div>