Original Issue Discount

<div class="Section1">Original issue discount is included in income in the same manner as Treasury securities issued before July&nbsp;2, 1982 (<em><em>see</em> </em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7651">7651</a>).<a href="#_ftn1" name="_ftnref1">¹</a><div class="Section1"><br /> <br /> However, if at the time of original issue there was an intention to call the obligation before maturity, the gain up to the entire original issue discount is treated as ordinary income.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> There was an intention to call before maturity if there was an understanding between the issuing corporation and the original purchaser that the issuer would redeem the obligation before maturity. The understanding need not have been communicated directly to the purchaser by the issuer and the understanding may have been conditional (e.g., it may have been dependent on the issuer&rsquo;s financial condition on the proposed call date). Whether there was an understanding depends on all the facts and circumstances. That the obligation on its face gave the issuer the privilege of redeeming the obligation before maturity is not determinative of an intention, and if the obligation was part of an issue registered with the SEC and sold to the public without representation that the obligor intended to call, it is presumed that there was no intention at issue to call.<a href="#_ftn3" name="_ftnref3">³</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;1271(c)(2).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp; IRC &sect;&nbsp;1271(c).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.1232-3(b)(4).<br /> <br /> </div></div><br />

<div class="Section1">If a bond is originally issued at a price that is less than its stated redemption price at maturity, the difference is original issue discount (OID). However, if the discount at which a bond was issued is less than &frac14; of 1&nbsp;percent (.0025) of the stated redemption price multiplied by the number of complete years to maturity, the bond is treated (for tax purposes) as if it were issued without a discount.<a href="#_ftn1" name="_ftnref1">¹</a><div class="Section1"><br /> <br /> If a bond is issued for property (stock or securities, or to the extent provided for in regulations, for other property in tax years ending after July&nbsp;18, 1984) and either the bond or the property is traded on an established market, the issue price of the bond is considered to be the fair market value of the property.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> The amount of original issue discount is included in income as it accrues over the life of the bond. For bonds issued after April&nbsp;4, 1994, OID must generally be accrued using the constant yield method. The holder of a bond may use accrual periods of different lengths provided that no accrual period is longer than one year. Payments may occur either on the first day or final day of an accrual period.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> The amount of original issue discount accruing each period is ratably allocated to each day in the period. These &ldquo;daily portions&rdquo; must be included in gross income by each owner for each day the owner holds the bond during the tax year.<a href="#_ftn4" name="_ftnref4">⁴</a> (More often than not, the individual&rsquo;s tax year will overlap two periods. If so, the owner simply totals the appropriate daily portions for the parts of each period that falls in his or her tax year.) Taxpayers who use the cash receipts and disbursement method of accounting and maintain a brokerage account that includes original issue discount debt instruments and stripped bonds must include in gross income for the taxable year the amount of accrued discount allocable to the portion of the taxable year in which they held the debt instruments. The taxpayers cannot defer the inclusion of original issue discount until it is actually received.<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <br /> Gain on the sale, exchange, or retirement of a bond is treated as ordinary income to the extent of unaccrued original issue discount if, at the time of original issue, there existed an intention to call the bond prior to maturity. According to regulations, an intention to call exists only if there is an agreement not provided for in the debt instrument that the issuer will redeem the instrument prior to maturity.<a href="#_ftn6" name="_ftnref6">⁶</a> This rule is not applicable to publicly offered bonds.<a href="#_ftn7" name="_ftnref7">⁷</a> The rules of this paragraph are effective for bonds issued on or after April&nbsp;4, 1994, and may be relied upon by taxpayers with bonds issued after December&nbsp;21, 1992.<br /> <br /> If the holder purchased the debt instrument at a premium or an acquisition premium or made an election to treat all interest as original interest discount, the amount of original issue discount must be adjusted.<a href="#_ftn8" name="_ftnref8">⁸</a> Furthermore, for bonds held on or after March&nbsp;2, 1998, a holder 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="7654">7654</a>).<a href="#_ftn9" name="_ftnref9">⁹</a><br /> <br /> The owner&rsquo;s basis is increased by the amount of discount included in income and decreased by the amount of any payment from the issuer to the holder under the debt instrument (other than a payment of qualified stated interest).<a href="#_ftn10" name="_ftnref10">¹⁰</a><br /> <br /> The application of these rules to bonds acquired in a debt-for-debt exchange in a corporate reorganization is covered in Treasury Regulation Section&nbsp;1.1272-2.<br /> <br /> The Service has ruled that a taxpayer who acquired two debt instruments that were structured so that it was expected that the value of one would increase significantly at the same time that the value of the other debt instrument would decrease significantly was not allowed to claim a current loss on the sale of the debt instrument that decreased in value while not recognizing the gain on the other debt instrument. The loss deductions for each set of debt instruments were denied under IRC Section&nbsp;165(a) and Treasury Regulation Sections 1.1275-6(c)(2) (the integration rule) and 1.1275-2(g) (the anti-abuse rule), respectively.<a href="#_ftn11" name="_ftnref11">¹¹</a><br /> <br /> Special rules apply to determine the inclusion in income of original issue discount on debt instruments issued after 1986 that have a maturity that is initially fixed, but that is accelerated based on prepayments on other debt obligations securing the debt instrument.<a href="#_ftn12" name="_ftnref12">¹²</a> For rules applying to variable rate debt instruments and debt instruments that provide for contingent payments, <em><em>see</em> </em>Treasury Regulation Section&nbsp;1.1272-1(b)(2). The sale of additional Treasury or corporate debt instruments that are issued after the original issue but that are treated as part of the original issue is referred to as a &ldquo;qualified reopening.&rdquo; For rules governing the treatment of original issue discount with respect to such sales, <em><em>see</em> </em>Treasury Regulation Sections 1.163-7(e), 1.1275-1(f), 1.1275-2(d); 1.1275-2(k), 1.1275-7(g). <em><em>See also</em></em> Revenue Procedure 2001-21<a href="#_ftn13" name="_ftnref13">¹³</a> (providing an election that will facilitate the substitution of newly issued bonds for outstanding bonds).<br /> <br /> These rules do not apply to tax-exempt bonds, to short-term government (federal or state) obligations (such as T-bills), to savings bonds (e.g., EE bonds), or to short-term corporate obligations.<a href="#_ftn14" name="_ftnref14">¹⁴</a><br /> <br /> The treatment of Treasury bills is discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7625">7625</a> and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7626">7626</a>, and short-term corporate obligations in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7627">7627</a> and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7628">7628</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;1273(a).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp; IRC &sect;&nbsp;1273(b)(3).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.1272-1(b)(1).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp;&nbsp; IRC &sect;&nbsp;1272(a)(1).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.&nbsp;&nbsp; <em>Gaffney v. Comm.,</em> TC Memo 1997-249.<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.1271-1(a)(1).<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.1271-1(a)(2)(i).<br /> <br /> <a href="#_ftnref8" name="_ftn8">8</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.1272-1(b)(3).<br /> <br /> <a href="#_ftnref9" name="_ftn9">9</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.171-4(a)(2).<br /> <br /> <a href="#_ftnref10" name="_ftn10">10</a>.&nbsp;&nbsp; IRC &sect;&nbsp;1272(d)(2); Treas. Reg. &sect;&nbsp;1.1272-1(g).<br /> <br /> <a href="#_ftnref11" name="_ftn11">11</a>.&nbsp;&nbsp; Rev. Rul. 2000-12, 2000-1 CB 744.<br /> <br /> <a href="#_ftnref12" name="_ftn12">12</a>.&nbsp;&nbsp; IRC &sect;&nbsp;1272(a)(6).<br /> <br /> <a href="#_ftnref13" name="_ftn13">13</a>.&nbsp;&nbsp; 2001-1 CB 742.<br /> <br /> <a href="#_ftnref14" name="_ftn14">14</a>.&nbsp;&nbsp; IRC &sect;&nbsp;1272(a).<br /> <br /> </div></div><br />

<div class="Section1">A prorated part of the original issue discount is included in income as interest each year, even though it is not actually received, unless the owner paid a premium (i.e., more than the stated redemption price) when the bond was purchased, or the obligation matured in one year or less. The amount is determined as follows:</div><br /> <div class="Section1"><br /> <br /> <em>By the original owner.</em> The original issue discount is divided by the number of complete months plus any fractional part of a month (as explained below) from the date of original issue through the day before the stated maturity date. (This is called the “ratable monthly portion.”)<a href="#_ftn1" name="_ftnref1">¹</a> The ratable monthly portion is multiplied by the number of complete months plus any fractional part of a month the taxpayer held the bond during the year.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> <em>By a subsequent owner.</em> Like the original owner, a subsequent owner includes in income each year a “ratable monthly portion” of original issue discount multiplied by the number of months plus fractional parts of a month the subsequent owner held the bond. However, he or she may determine the ratable monthly portion in a different way if it results in a lower amount. Instead of dividing the original issue discount by the term of the bond, the subsequent owner may divide the amount by which the bond’s stated redemption price at maturity exceeds the bond’s cost to him or her by the number of complete months plus any fractional part of a month beginning on the day of purchase of the obligation and ending on the day before the stated maturity date of the obligation.<a href="#_ftn3" name="_ftnref3">³</a> An individual is not considered to have “purchased” the bond if the bond’s basis is determined, in whole or in part, by reference to the basis of the obligation in the hands of the person from whom it was acquired, or by reference to the estate tax valuation.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> Thus, if the amount paid by the subsequent owner is not more than the original issue price plus all amounts of original issue discount previously includable (whether or not included) in income by previous holders, his or her ratable monthly portion of the original issue discount is calculated like the original holder’s. However, if the subsequent owner paid more than the original issue price plus the amount of original issue discount includable in the income of any previous holder, he or she may reduce the original issue discount remaining by the excess amount before determining the monthly portion. This excess amount is called an “acquisition premium.” (In computing the amount of original issue discount includable by previous holders, one does not take into consideration any acquisition premium paid by previous holders or that a holder may, in fact, have purchased at a premium.)<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <br /> For either an original or subsequent holder, a complete or fractional month begins with the date of original issue and the corresponding day of each following calendar month (or the last day of a calendar month in which there is no corresponding day). If a holder sells the bond on any other day in the month, a part of the ratable monthly portion for that month is allocated between the seller and buyer based on the number of days in the month each held the bond. (Seller and buyer may allocate on the basis of a 30-day month.) The transferee is deemed to hold the obligations the entire day of acquisition, but not on the day of redemption.<a href="#_ftn6" name="_ftnref6">⁶</a><br /> <br /> The original or any subsequent holder increases the holder’s basis by amounts of includable original issue discount actually included in income.<a href="#_ftn7" name="_ftnref7">⁷</a><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>.   Treas. Reg. § 1.1232-3A(a)(2)(i); IRC § 1272(b)(2).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.   IRC § 1272(b)(1); Treas. Reg. § 1.1232-3A(a)(1).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.   IRC § 1272(b)(4); Treas. Reg. §§ 1.1232-3A(a)(2)(ii), 1.1232-3A(a)(3)(i).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.   IRC § 1272(d); Treas. Reg. § 1.1232-3A(a)(4).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.   IRC § 1272(b); Treas. Reg. § 1.1232-3A(a)(2)(ii).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>.   Treas. Reg. § 1.1232-3A(a)(3).<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>.   IRC § 1272(d)(2); Treas. Reg. § 1.1232-3A(c).<br /> <br /> </div>

<div class="Section1">Any original issue discount on Treasury notes and bonds issued between January&nbsp;1, 1955, and July&nbsp;1, 1982 (inclusive), is not included in income until the bond is sold or redeemed.<a href="#_ftn1" name="_ftnref1">¹</a> (If the discount at issue was less than &frac14; of 1&nbsp;percent (.0025) of the stated redemption price, multiplied by the number of full years from the date of original issue to maturity, the bond is not considered issued at a discount.)<a href="#_ftn2" name="_ftnref2">²</a><div class="Section1"><br /> <br /> If the owner purchased the bond at a premium (i.e., at a price above the stated redemption price), no original issue discount is included in income on the sale or maturity of the obligation.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> If the obligation is sold or redeemed by a seller who did not buy at a premium and <em>gain</em> is realized, a part of the proceeds must be treated by the seller as ordinary income attributable to the original issue discount. The amount of discount treated as ordinary income is based on the proportionate part of the time from issue to the date of maturity that the seller held the obligation, and it is computed by multiplying the original issue discount by a fraction having as numerator the number of full months the obligation was held by the seller and as denominator the number of full months from the date of original issue to the stated date of maturity.<a href="#_ftn4" name="_ftnref4">⁴</a> Any days amounting to less than a full month are not counted.<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <br /> In determining how many months the seller held the obligation, he or she must include any period it was held by another person if the seller&rsquo;s tax basis for determining gain or loss is the same, in whole or in part, as it would be in the hands of the other person.<a href="#_ftn6" name="_ftnref6">⁶</a><br /> <br /> U.S. Savings Bonds are discussed at Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7679">7679</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7689">7689</a>. Treasury Bills are discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7625">7625</a> and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7626">7626</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;1271(c)(2).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp; IRC &sect;&nbsp;1273(a)(3).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp; IRC &sect;&nbsp;1271(a)(2)(B). <em><em>See</em> </em>Treas. Reg. &sect;&nbsp;1.1232-3(d). <em><em>See also</em></em> Treas. Reg. &sect;&nbsp;1.1272-2.<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp;&nbsp; IRC &sect;&nbsp;1271(c).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.1232-3(c), Ex.(1).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.1232-3(c).<br /> <br /> </div></div><br />