[4830-01-u]
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[FI-48-95]
RIN 1545-AU09
Amortizable Bond Premium
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking and notice of public
hearing.
SUMMARY: This document contains proposed regulations relating to
the federal income tax treatment of bond premium and bond
issuance premium. The proposed regulations reflect changes to
the law made by the Tax Reform Act of 1986 and the Technical and
Miscellaneous Revenue Act of 1988. The proposed regulations in
this document would provide needed guidance to holders and
issuers of debt instruments. This document also provides a
notice of a public hearing on the proposed regulations.
DATES: Written comments must be received by September 25, 1996.
Requests to appear and outlines of topics to be discussed at the
public hearing scheduled for October 23, 1996, at 10 a.m. must be
received by October 2, 1996.
ADDRESSES: Send submissions to: CC:DOM:CORP:R (FI-48-95), room
5226, Internal Revenue Service, POB 7604, Ben Franklin Station,
Washington, DC 20044. In the alternative, submissions may be
hand delivered between the hours of 8 a.m. and 5 p.m. to:
CC:DOM:CORP:R (FI-48-95), Courier's Desk, Internal Revenue
Service, 1111 Constitution Avenue NW, Washington, DC. A public
hearing will be held in the Commissioner's Conference Room,
Internal Revenue Building, 1111 Constitution Avenue NW,
Washington, DC.
FOR FURTHER INFORMATION CONTACT: Concerning the regulations,
William P. Cejudo, (202) 622-4016, or Jeffrey W. Maddrey, (202)
622-3940; concerning submissions and the hearing, Christina
Vasquez, (202) 622-7190 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collections of information contained in this notice of
proposed rulemaking have been submitted to the Office of
Management and Budget for review in accordance with the Paperwork
Reduction Act of 1995 (44 U.S.C. 3507).
Comments on the collections of information should be sent to
the Office of Management and Budget, Attn: Desk Officer for the
Department of Treasury, Office of Information and Regulatory
Affairs, Washington, DC 20503, with copies to the Internal
Revenue Service, Attn: IRS Reports Clearance Officer, T:FP,
Washington, DC 20224. Comments on the collections of information
should be received by August 26, 1996.
An agency may not conduct or sponsor, and a person is not
required to respond to, a collection of information unless the
collection of information displays a valid control number.
The collections of information are in proposed
1.163-13(h)(3), 1.171-4(a)(1), and 1.171-5(c)(2)(iii). This
information is required by the IRS to monitor compliance with the
federal tax rules for amortizing bond premium and bond issuance
premium. The likely respondents are taxpayers who either acquire
a bond at a premium or issue a bond at a premium. Responses to
this collection of information are required to determine whether
a holder of a bond has elected to amortize bond premium and to
determine whether an issuer or a holder has changed its method of
accounting for premium.
Books or records relating to a collection of information
must be retained as long as their contents may become material in
the administration of any internal revenue law. Generally, tax
returns and tax return information are confidential, as required
by 26 U.S.C. 6103.
Estimated total annual reporting burden: 50,000 hours. The
estimated annual burden per respondent varies from 0.25 hours to
0.75 hours, depending on individual circumstances, with an
estimated average of 0.5 hours.
Estimated number of respondents: 100,000.
Estimated annual frequency of responses: One time per
respondent.
Background
Sections 1.171-1 through 1.171-4 of the Income Tax
Regulations were promulgated in 1957 and last amended in 1968.
In the Tax Reform Act of 1986, section 171(b) was amended to
require that bond premium be amortized by reference to a constant
yield. In the Technical and Miscellaneous Revenue Act of 1988,
section 171(e) was amended to require that bond premium be
amortized as an offset to interest income. The proposed
regulations would substantially revise the existing regulations
to reflect these amendments. In addition, the proposed
regulations would revise existing guidance addressing the
issuer's treatment of bond issuance premium.
Explanation of Provisions
In general, bond premium arises when a holder acquires a
bond for more than the principal amount of the bond. Similarly,
bond issuance premium arises when an issuer issues a bond for
more than the principal amount of the bond. A holder will
purchase, and an issuer will issue, a bond for more than its
principal amount when the stated interest rate on the bond is
higher than the current market yield for the bond.
The holder's treatment of bond premium is addressed in
proposed regulations under section 171. The issuer's treatment
of bond issuance premium is addressed in proposed regulations
under section 163. In each case, the amortization of premium is
based on constant yield principles. For this reason, the
proposed regulations use concepts and definitions from the
original issue discount (OID) regulations (1.1271-0 through
1.1275-6).
Determination of bond premium
Under the proposed regulations, bond premium is defined as
the excess of a holder's basis in a bond over the sum of the
remaining amounts payable on the bond other than payments of
qualified stated interest. The holder generally determines the
amount of bond premium as of the date the holder acquires the
bond.
The proposed regulations provide special rules that limit a
holder's basis solely for purposes of determining bond premium.
For example, if a bond is convertible into stock of the issuer at
the holder's option, for purposes of determining bond premium,
the holder must reduce its basis in the bond by the value of the
conversion option. This reduction prevents the holder from
inappropriately amortizing the cost of the embedded conversion
option.
Amortization of bond premium
Under section 171, the holder of a taxable bond acquired at
a premium may elect to amortize bond premium. The holder of a
tax-exempt bond acquired at a premium must amortize the premium.
As premium is amortized, the holder's basis in the bond is
reduced by a corresponding amount under section 1016(a)(5).
Under the proposed regulations, a holder amortizes bond
premium by offsetting qualified stated interest income with bond
premium. An offset is calculated for each accrual period using
constant yield principles. ob体育ever, the offset for an accrual
period is only taken into account when the holder takes qualified
stated interest into account under the holder's regular method of
accounting. Thus, a holder using the cash receipts and
disbursements method of accounting does not take bond premium
into account until a qualified stated interest payment is
received.
For certain bonds (e.g., bonds that pay a variable rate of
interest or that provide for an interest holiday), the amount of
bond premium allocable to an accrual period could exceed the
amount of qualified stated interest allocable to that period.
The proposed regulations address this situation by providing that
the excess bond premium is not allowed as a deduction but is
carried forward to future accrual periods.
Variable rate debt instruments
Because a variable rate debt instrument (VRDI) provides for
variable interest payments, the yield and payment schedule of a
VRDI cannot be determined without making assumptions about the
amount of the variable payments. Under the OID regulations, OID
on a VRDI is determined and allocated among accrual periods by
reference to an equivalent fixed rate debt instrument constructed
as of the issue date of the VRDI. The proposed regulations
provide that bond premium on a VRDI is determined and allocated
in a similar manner. Under the proposed regulations, bond
premium on a VRDI is determined and allocated by reference to an
equivalent fixed rate debt instrument. ob体育ever, the equivalent
fixed rate debt instrument is constructed as of the date the
holder acquires the VRDI rather than the issue date.
Bonds subject to certain contingencies
If a bond provides for one or more alternative payment
schedules, the yield of the bond cannot be determined without
making assumptions about the actual payment schedule. The OID
regulations provide three rules for making these assumptions.
First, if one payment schedule is significantly more likely than
not to occur, the yield of the debt instrument is determined by
reference to this payment schedule. Second, if the debt
instrument is subject to a mandatory sinking fund provision, the
yield is determined without regard to the mandatory sinking fund
provision. Third, notwithstanding the first two rules, if the
debt instrument provides for an unconditional option or options
to alter the payment schedule, the yield is determined by
assuming that the issuer will exercise its options in the manner
that minimizes the yield of the debt instrument and that the
holder will exercise its options in the manner that maximizes the
yield of the debt instrument.
The proposed regulations generally use similar assumptions
to determine the holder's yield on a bond that provides for
alternative payment schedules. ob体育ever, in the case of an
issuer's option on a taxable bond, the proposed regulations
reverse the assumption by assuming that the issuer will exercise
the option only if doing so would increase the yield on the bond.
See section 171(b)(1)(B)(ii). As a result of this rule, a holder
generally must amortize bond premium on a taxable bond by
reference to the stated maturity date, even if it appears likely
the bond will be called. In this case, if the bond is actually
called, the proposed regulations provide that the holder may
deduct the unamortized premium. If the bond is partially called
and the partial call is not a pro-rata prepayment, the proposed
regulations do not allow the holder to deduct a portion of the
unamortized premium. Instead, the holder must recompute the
yield of the bond on the date of the partial call and amortize
the remaining premium by reference to the recomputed yield.
Treasury and IRS request comments on the application of the
alternative payment schedule rules. Specifically, comments are
requested on whether the "significantly more likely than not to
occur" standard is appropriate for taxable bonds, whether
ignoring mandatory sinking fund provisions is appropriate for
tax-exempt bonds, and whether the distinction between pro-rata
and non-pro-rata calls is appropriate.
Bond issuance premium
Under existing 1.61-12(c), a corporate issuer treats
premium received upon issuance of a bond as a separate item of
income. Over the term of the bond, the premium is taken into
income, and the full amount of the stated interest is deducted.
The proposed regulations would revise the treatment of bond
issuance premium. Under the proposed regulations, bond issuance
premium is amortized as an offset to the issuer's otherwise
allowable interest deduction, not as a separate item of income.
The amount of bond issuance premium amortized in any period is
based on a constant yield. In addition, the proposed regulations
would apply to all issuers, not just corporate issuers.
De minimis rules and aggregate rules
The proposed regulations do not provide rules for de minimis
amounts of premium or for aggregate methods of accounting for
premium. Treasury and IRS request comments on whether de minimis
rules or aggregate rules are necessary or appropriate.
Bonds not subject to the proposed regulations
The proposed regulations generally apply to bonds acquired
or issued at a premium. Certain bonds, however, are excluded
from the application of the proposed regulations. For example,
the proposed regulations exclude debt instruments subject to
section 1272(a)(6) (relating to certain prepayable debt
instruments). No inference is intended regarding the treatment
of these debt instruments.
Proposed effective dates
The proposed regulations relating to bond premium provide
that the final regulations generally will apply to bonds acquired
on or after the date 60 days after the date final regulations are
published in the Federal Register. ob体育ever, if a holder makes
the election to amortize bond premium for the taxable year
containing the date 60 days after the date final regulations are
published, the regulations apply to bonds held on or after the
first day of that taxable year.
The proposed regulations relating to bond issuance premium
provide that the final regulations will apply to debt instruments
issued on or after the date 60 days after the date final
regulations are published in the Federal Register.
The proposed regulations also would provide automatic
consent for a taxpayer to change its method of accounting for
premium in certain circumstances. Because the change is made on
a cut-off basis, no items of income or deduction are omitted or
duplicated. Therefore, no adjustment under section 481 is
allowed.
Special Analyses
It has been determined that this notice of proposed
rulemaking is not a significant regulatory action as defined in
EO 12866. Therefore, a regulatory assessment is not required.
It also has been determined that section 553(b) of the
Administrative Procedure Act (5 U.S.C. chapter 5) and the
Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to
these regulations, and, therefore, a Regulatory Flexibility
Analysis is not required. Pursuant to section 7805(f) of the
Internal Revenue Code, this notice of proposed rulemaking will be
submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on its impact on small business.
Comments and Public Hearing
Before these proposed regulations are adopted as final
regulations, consideration will be given to any written comments
(a signed original and eight (8) copies) that are submitted
timely to the IRS. All comments will be available for public
inspection and copying.
A public hearing has been scheduled for October 23, 1996, at
10 a.m. in the Commissioner's Conference Room, Internal Revenue
Building, 1111 Constitution Avenue NW, Washington, DC. Because
of access restrictions, visitors will not be admitted beyond the
building lobby more than 15 minutes before the hearing starts.
The rules of 26 CFR 601.601(a)(3) apply to the hearing.
Persons that wish to present oral comments at the hearing
must submit written comments by September 25, 1996, and submit an
outline of the topics to be discussed and the time to be devoted
to each topic (signed original and eight (8) copies) by October
2, 1996.
A period of 10 minutes will be allotted to each person for
making comments.
An agenda showing the scheduling of the speakers will be
prepared after the deadline for receiving outlines has passed.
Copies of the agenda will be available free of charge at the
hearing.
Drafting Information
The principal authors of these regulations are William P.
Cejudo and Jeffrey W. Maddrey of the Office of Assistant Chief
Counsel (Financial Institutions and Products). ob体育ever, other
personnel from the IRS and Treasury Department participated in
their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as
follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended
by adding entries in numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.171-2 also issued under 26 U.S.C. 171(e).
Section 1.171-3 also issued under 26 U.S.C. 171(e).
Section 1.171-4 also issued under 26 U.S.C. 171(c). * * *
Par. 2. Section 1.61-12 is amended by revising paragraph
(c) to read as follows:
1.61-12 Income from discharge of indebtedness.
* * * * *
(c) Issuance and repurchase of debt instruments--(1)
Issuance. An issuer does not realize gain or loss upon the
issuance of a debt instrument (as defined in 1.1275-1(d)).
(2) Repurchase--(i) In general. An issuer does not realize
gain or loss upon the repurchase of a debt instrument. For
purposes of this paragraph (c)(2), the term repurchase includes
the retirement of a debt instrument, the conversion of a debt
instrument into stock of the issuer, and the exchange (including
an exchange under section 1001) of a newly issued debt instrument
for an existing debt instrument.
(ii) Repurchase at a discount. An issuer realizes income
from the discharge of indebtedness upon the repurchase of a debt
instrument for an amount less than its adjusted issue price (as
defined in 1.163-13(d)(5)). The amount of discharge of
indebtedness income is equal to the excess of the adjusted issue
price over the repurchase price. To determine the repurchase
price of a debt instrument that is repurchased through the
issuance of a new debt instrument, see section 108(e)(10). See
1.108-2 for rules relating to the realization of discharge of
indebtedness income upon the acquisition of a debt instrument by
a person related to the issuer.
(iii) Repurchase at a premium. An issuer may be entitled to
a repurchase premium deduction upon the repurchase of a debt
instrument for an amount greater than its adjusted issue price
(as defined in 1.163-13(d)(5)). See 1.163-7(c) for the
treatment of repurchase premium.
(3) Bond issuance premium. For rules relating to an
issuer's interest deduction for a debt instrument issued with
bond issuance premium, see 1.163-13.
(4) Effective date. This paragraph (c) applies to debt
instruments issued on or after the date that is 60 days after the
date final regulations are published in the Federal Register.
* * * * *
Par. 3. Section 1.163-7 is amended by revising the first
sentence of paragraph (c) to read as follows:
1.163-7 Deduction for OID on certain debt instruments.
* * * * *
(c) Deduction upon repurchase. Except to the extent
disallowed by any other section of the Internal Revenue Code
(e.g., section 249) or this paragraph (c), if a debt instrument
is repurchased by the issuer for a price in excess of its
adjusted issue price (as defined in 1.163-13(d)(5)), the excess
(repurchase premium) is deductible as interest for the taxable
year in which the repurchase occurs. * * *
* * * * *
Par. 4. Section 1.163-13 is added to read as follows:
1.163-13 Treatment of bond issuance premium.
(a) General rule. If a debt instrument is issued with bond
issuance premium, this section limits the amount of the issuer's
interest deduction otherwise allowable under section 163(a). In
general, the issuer determines its interest deduction by
offsetting the interest allocable to an accrual period with the
bond issuance premium allocable to that period. Bond issuance
premium is allocable to an accrual period based on a constant
yield. The use of a constant yield to amortize bond issuance
premium is intended to conform the treatment of debt instruments
having bond issuance premium with those having original issue
discount. Unless otherwise provided, the terms used in this
section have the same meaning as those terms in section 163(e),
sections 1271 through 1275, and the corresponding regulations.
Moreover, the provisions of this section apply in a manner
consistent with those of section 163(e), sections 1271 through
1275, and the corresponding regulations. In addition, the anti-
abuse rule in 1.1275-2(g) applies for purposes of this section.
For rules dealing with the treatment of bond premium by a holder,
see 1.171-1 through 1.171-5.
(b) Exceptions. This section does not apply to--
(1) A debt instrument to which section 1272(a)(6) applies
(relating to certain interests in or mortgages held by a REMIC,
and certain other debt instruments with payments subject to
acceleration); or
(2) A debt instrument to which 1.1275-4 applies (relating
to certain debt instruments that provide for contingent
payments).
(c) Bond issuance premium. Bond issuance premium is the
excess, if any, of the issue price of a debt instrument over its
stated redemption price at maturity. For purposes of this
section, the issue price of a convertible bond (as defined in
1.171-1(e)(1)(iii)(C)) does not include an amount equal to the
value of the conversion option.
(d) Offsetting qualified stated interest with bond issuance
premium--(1) In general. An issuer amortizes bond issuance
premium by offsetting the qualified stated interest allocable to
an accrual period with the bond issuance premium allocable to the
accrual period. This offset occurs when the issuer takes the
qualified stated interest into account under its regular method
of accounting.
(2) Qualified stated interest allocable to an accrual
period. See 1.446-2(b) to determine the accrual period to which
qualified stated interest is allocable and to determine the
accrual of qualified stated interest within an accrual period.
(3) Bond issuance premium allocable to an accrual period.
The bond issuance premium allocable to an accrual period is
determined under this paragraph (d)(3). Within an accrual
period, the bond issuance premium allocable to the period accrues
ratably.
(i) Step one: Determine the debt instrument's yield to
maturity. The yield to maturity of a debt instrument is
determined under the rules of 1.1272-1(b)(1)(i).
(ii) Step two: Determine the accrual periods. The accrual
periods are determined under the rules of 1.1272-1(b)(1)(ii).
(iii) Step three: Determine the bond issuance premium
allocable to the accrual period. The bond issuance premium
allocable to an accrual period is the excess of the qualified
stated interest allocable to the accrual period over the product
of the adjusted issue price at the beginning of the accrual
period and the yield. In performing this calculation, the yield
must be stated appropriately taking into account the length of
the particular accrual period. Principles similar to those in
1.1272-1(b)(4) apply in determining the bond issuance premium
allocable to an accrual period.
(4) Bond issuance premium in excess of qualified stated
interest. If the bond issuance premium allocable to an accrual
period exceeds the qualified stated interest allocable to the
accrual period for a debt instrument, the excess is carried
forward to the next accrual period and offsets qualified stated
interest in that accrual period to the extent of the disallowed
amount. If the amount carried forward to an accrual period
exceeds the qualified stated interest for that period, the excess
is carried forward to subsequent accrual periods, beginning with
the next accrual period, and is used to offset qualified stated
interest in those accrual periods to the extent of the excess.
If an excess amount exists on the date the debt instrument is
retired, the issuer takes this amount into account as ordinary
income.
(5) Adjusted issue price. In general, the adjusted issue
price of a debt instrument is determined under the rules of
1.1275-1(b). In addition, the adjusted issue price of the debt
instrument is decreased by the amount of bond issuance premium
previously allocable under paragraph (d)(3) of this section.
(e) Special rules--(1) Variable rate debt instruments issued
with bond issuance premium. Bond issuance premium on a variable
rate debt instrument is determined by reference to the stated
redemption price at maturity of the equivalent fixed rate debt
instrument constructed as of the issue date. In addition, the
issuer allocates bond issuance premium on a variable rate debt
instrument among the accrual periods by reference to the
equivalent fixed rate debt instrument. The equivalent fixed rate
debt instrument is determined using the principles of
1.1275-5(e).
(2) Remote and incidental contingencies. For purposes of
determining and amortizing bond issuance premium, if a bond
provides for a contingency that is remote or incidental (within
the meaning of 1.1275-2(h)), the contingency is taken into
account under the rules for remote and incidental contingencies
in 1.1275-2(h).
(f) Example. The following example illustrates the rules of
this section.
Example--(i) Facts. On February 1, 1999, X issues for
$110,000 a debt instrument maturing on February 1, 2006, with a
stated principal amount of $100,000, payable at maturity. The
debt instrument provides for unconditional payments of interest
of $10,000, payable on February 1 of each year. X uses the
calendar year as its taxable year, X uses the cash receipts and
disbursements method of accounting, and X decides to use annual
accrual periods ending on February 1 of each year. X's
calculations assume a 30-day month and 360-day year.
(ii) Amount of bond issuance premium. The issue price of
the debt instrument is $110,000. Because the interest payments
on the debt instrument are qualified stated interest, the stated
redemption price at maturity of the debt instrument is $100,000.
Therefore, the amount of bond issuance premium is $10,000
($110,000 - $100,000).
(iii) Bond issuance premium allocable to the first accrual
period. Based on the payment schedule and the issue price of the
debt instrument, the yield of the debt instrument is 8.07
percent, compounded annually. (Although, for purposes of
simplicity, the yield as stated is rounded to two decimal places,
the computations do not reflect this rounding convention.) The
bond issuance premium allocable to the accrual period ending on
February 1, 2000, is the excess of the qualified stated interest
allocable to the period ($10,000) over the product of the
adjusted issue price at the beginning of the period ($110,000)
and the yield (8.07 percent, compounded annually). Therefore,
the bond issuance premium allocable to the accrual period is
$1,118.17 ($10,000 - $8,881.83).
(iv) Premium used to offset interest. Although X makes an
interest payment of $10,000 on February 1, 2000, X only deducts
interest of $8,881.83, the qualified stated interest allocable to
the period ($10,000) offset with bond issuance premium allocable
to the period ($1,118.17).
(g) Effective date. This section applies to debt
instruments issued on or after the date that is 60 days after the
date final regulations are published in the Federal Register.
(h) Consent to change method of accounting. The
Commissioner grants consent for an issuer to change its method of
accounting for bond issuance premium on debt instruments issued
on or after the date that is 60 days after the date final
regulations are published in the Federal Register. ob体育ever, this
consent is granted only if--
(1) The change is made to comply with this section;
(2) The change is made for the first taxable year for which
the issuer must account for a debt instrument under this section;
and
(3) The issuer attaches to its federal income tax return for
the taxable year containing the change a statement that it has
changed its method of accounting under this section.
Par. 5. Sections 1.171-1 through 1.171-4 are revised to
read as follows:
1.171-1 Bond premium.
(a) Overview--(1) In general. This section and 1.171-2
through 1.171-5 provide rules for the determination and
amortization of bond premium by a holder. In general, a holder
amortizes bond premium by offsetting the interest allocable to an
accrual period with the premium allocable to that period. Bond
premium is allocable to an accrual period based on a constant
yield. The use of a constant yield to amortize bond premium is
intended generally to conform the treatment of bond premium to
the treatment of original issue discount under sections 1271
through 1275. Unless otherwise provided, the terms used in this
section and 1.171-2 through 1.171-5 have the same meaning as
those terms in sections 1271 through 1275 and the corresponding
regulations. Moreover, the provisions of this section and
1.171-2 through 1.171-5 apply in a manner consistent with those
of sections 1271 through 1275 and the corresponding regulations.
In addition, the anti-abuse rule in 1.1275-2(g) applies for
purposes of this section and 1.171-2 through 1.171-5.
(2) Cross-references. For rules dealing with the
adjustments to a holder's basis to reflect the amortization of
bond premium, see 1.1016-5(b). For rules dealing with the
treatment of bond issuance premium by an issuer, see 1.163-13.
(b) Scope--(1) In general. Except as provided in paragraph
(b)(2) of this section, this section and 1.171-2 through
1.171-5 apply to any bond that, upon its acquisition by the
holder, is held with bond premium. For purposes of this section
and 1.171-2 through 1.171-5, the term bond has the same meaning
as the term debt instrument in 1.1275-1(d).
(2) Exceptions. This section and 1.171-2 through 1.171-5
do not apply to--
(i) A bond to which section 1272(a)(6) applies (relating to
certain interests in or mortgages held by a REMIC, and certain
other debt instruments with payments subject to acceleration);
(ii) A bond to which 1.1275-4 applies (relating to certain
debt instruments that provide for contingent payments);
(iii) A bond held by a holder that has made a 1.1272-3
election with respect to the bond;
(iv) 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's trade or business; or
(v) A bond issued before September 28, 1985, unless the bond
bears interest and was issued by a corporation or by a government
or political subdivision thereof.
(c) General rule--(1) Tax-exempt obligations. A holder must
amortize bond premium on a bond that is a tax-exempt obligation.
See 1.171-2(c) Example 4.
(2) Taxable bonds. A holder may elect to amortize bond
premium on a taxable bond. Except as provided in paragraph
(c)(3) of this section, a taxable bond is any bond other than a
tax-exempt obligation. See 1.171-4 for rules relating to the
election to amortize bond premium on a taxable bond.
(3) Bonds the interest on which is partially excludable.
For purposes of this section and 1.171-2 through 1.171-5, a
bond the interest on which is partially excludable from gross
income (e.g., a securities acquisition loan under section 133) is
treated as two instruments, a tax-exempt obligation and a taxable
bond. The holder's basis in the bond and each payment on the
bond are allocated between the two instruments based on the ratio
of the interest excludable to the total interest payable on the
bond.
(d) Determination of bond premium--(1) In general. A holder
acquires a bond at a 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). This excess
is bond premium, which is amortizable under 1.171-2.
(2) Additional rules for amounts payable on certain bonds.
Additional rules apply to determine the amounts payable on a
variable rate debt instrument and on a bond that provides for
certain alternative payment schedules. See 1.171-3.
(e) Basis. A holder determines its basis in a bond under
this paragraph (e). This determination of basis applies only for
purposes of this section and 1.171-2 through 1.171-5. Because
of the application of this paragraph (e), the holder's basis in
the bond for purposes of these sections may differ from the
holder's basis for determining gain or loss on the sale or
exchange of the bond.
(1) Determination of basis--(i) In general. In general, the
holder's basis in the bond is the holder's basis for determining
loss on the sale or exchange of the bond.
(ii) Bonds acquired in certain exchanges. If the holder
acquired the bond in exchange for other property (other than in a
reorganization defined in section 368) and the holder's basis in
the bond is determined in whole or in part by reference to the
holder's basis in the other property, the holder's basis in the
bond may not exceed its fair market value immediately after the
exchange. See paragraph (f) Example 1 of this section. If the
bond is acquired in a reorganization, see section 171(b)(4)(B).
(iii) Convertible bonds--(A) General rule. If the bond is a
convertible bond, the holder'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. See paragraph (f) Example 2 of this
section.
(B) Convertible bonds acquired in certain exchanges. If the
bond is a convertible bond acquired in a transaction described in
paragraph (e)(1)(ii) of this section, the holder's basis in the
bond may not exceed its fair market value immediately after the
exchange reduced by the value of the conversion option.
(C) Definition of convertible bond. A convertible bond is a
bond that provides the holder with an option to convert the bond
into stock of the issuer, stock or debt of a related party
(within the meaning of section 267(b) or 707(b)(1)), or into cash
or other property in an amount equal to the approximate value of
that stock or debt.
(2) Basis in bonds held by certain transferees.
Notwithstanding paragraph (e)(1) of this section, if the bond is
transferred basis property (as defined in section 7701(a)(43))
and the transferor had acquired the bond at a premium, the
holder's basis in the bond is--
(i) The holder's basis for determining loss on the sale or
exchange of the bond; reduced by
(ii) Any amounts that the transferor could not have
amortized under this paragraph (e) or under 1.171-4(c).
(f) Examples. The following examples illustrate the rules
of this section.
Example 1. Bond received in liquidation of a partnership
interest--(i) Facts. PR is a partner in partnership PRS. PRS
does not have any unrealized receivables or substantially
appreciated inventory items as defined in section 751. On
January 1, 1997, PRS distributes to PR a taxable bond, issued by
an unrelated corporation, in liquidation of PR's partnership
interest. At that time, the fair market value of PR's
partnership interest is $40,000 and the basis is $100,000. The
fair market value of the bond is $40,000.
(ii) Determination of basis. Under section 732(b), PR's
basis in the bond is equal to PR's basis in the partnership
interest. Therefore, PR's basis for determining loss on the sale
or exchange of the bond is $100,000. ob体育ever, under paragraph
(e)(1)(ii) of this section, PR's basis in the bond is $40,000 for
purposes of this section and 1.171-2 through 1.171-5.
Example 2. Convertible bond--(i) Facts. On January 1,
1997, A purchases for $1,100 B corporation's bond maturing on
January 1, 2000, with a stated principal amount of $1,000,
payable at maturity. The bond provides for unconditional
payments of interest of $30 on January 1 and July 1 of each year.
In addition, the bond is convertible into 15 shares of B
corporation stock at the option of the holder. On January 1,
1997, B corporation's nonconvertible, publicly-traded, three-year
debt with similar credit rating trades at a price that reflects a
yield of 6.75 percent, compounded semiannually.
(ii) Determination of basis. A's basis for determining loss
on the sale or exchange of the bond is $1,100. As of January 1,
1997, discounting the remaining payments on the bond at the yield
at which B's similar nonconvertible bonds trade (6.75 percent,
compounded semiannually) results in a present value of $980.
Thus, the value of the conversion option is $120. Under
paragraph (e)(1)(iii)(A) of this section, A's basis is $980
($1,100 - $120) for purposes of this section and 1.171-2
through 1.171-5. The sum of all amounts payable on the bond
other than qualified stated interest is $1,000. Because A's
basis (as determined under paragraph (e)(1)(iii)(A) of this
section) does not exceed $1,000, A does not acquire the bond at a
premium.
1.171-2 Amortization of bond premium.
(a) Offsetting qualified stated interest with
premium--(1) In general. 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.
This offset occurs when the holder takes the qualified stated
interest into account under the holder's regular method of
accounting.
(2) Qualified stated interest allocable to an accrual
period. See 1.446-2(b) to determine the accrual period to which
qualified stated interest is allocable and to determine the
accrual of qualified stated interest within an accrual period.
(3) Bond premium allocable to an accrual period. The bond
premium allocable to an accrual period is determined under this
paragraph (a)(3). Within an accrual period, the bond premium
allocable to the period accrues ratably.
(i) 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 as determined
under 1.171-1(e). For this purpose, the remaining payments
include only payments to be made after the date the holder
acquires the bond. The yield is 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.
(ii) Step two: Determine the accrual periods. A holder
determines the accrual periods for the bond under the rules of
1.1272-1(b)(1)(ii).
(iii) 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 (as defined in paragraph (b) of this section)
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. Principles similar to those in 1.1272-1(b)(4)
apply in determining the bond premium allocable to an accrual
period.
(4) Bond premium in excess of qualified stated interest. If
the bond premium allocable to an accrual period exceeds the
qualified stated interest allocable to the accrual period for
that bond, the excess is carried forward to the next accrual
period and offsets qualified stated interest in that accrual
period to the extent of the disallowed amount. If the bond
premium carried forward to an accrual period exceeds the
qualified stated interest for that period, the excess is carried
forward to subsequent accrual periods, beginning with the next
accrual period, and is used to offset qualified stated interest
in those accrual periods to the extent of the excess.
(5) Additional rules for certain bonds. Additional rules
apply to determine the amortization of bond premium on a variable
rate debt instrument and on a bond that provides for certain
alternative payment schedules. See 1.171-3.
(b) Adjusted acquisition price. The adjusted acquisition
price of a bond at the beginning of the first accrual period is
the holder's basis as determined under 1.171-1(e). Thereafter,
the adjusted acquisition price is the holder's basis in the bond
decreased by--
(1) The amount of bond premium previously allocable under
paragraph (a)(3) of this section; and
(2) The amount of any payment previously made on the bond
other than a payment of qualified stated interest.
(c) Examples. The following examples illustrate the rules
of this section. Each example assumes the holder uses the
calendar year as its taxable year and has elected to amortize
bond premium, effective for all relevant taxable years. In
addition, each example assumes a 30-day month and 360-day year.
Although, for purposes of simplicity, the yield as stated is
rounded to two decimal places, the computations do not reflect
this rounding convention.
Example 1. Taxable bond--(i) Facts. On February 1, 1999, A
purchases for $110,000 a taxable bond maturing on February 1,
2006, with a stated principal amount of $100,000, payable at
maturity. The bond provides for unconditional payments of
interest of $10,000, payable on February 1 of each year. A uses
the cash receipts and disbursements method of accounting, and A
decides to use annual accrual periods ending on February 1 of
each year.
(ii) Amount of bond premium. The interest payments on the
bond are qualified stated interest. Therefore, the sum of all
amounts payable on the bond (other than the interest payments) is
$100,000. Under 1.171-1, the amount of bond premium is $10,000
($110,000 - $100,000).
(iii) Bond premium allocable to the first accrual period.
Based on the remaining payment schedule of the bond and A's basis
in the bond, A's yield is 8.07 percent, compounded annually. The
bond premium allocable to the accrual period ending on February
1, 2000, is the excess of the qualified stated interest allocable
to the period ($10,000) over the product of the adjusted
acquisition price at the beginning of the period ($110,000) and
A's yield (8.07 percent, compounded annually). Therefore, the
bond premium allocable to the accrual period is $1,118.17
($10,000 - $8,881.83).
(iv) Premium used to offset interest. Although A receives
an interest payment of $10,000 on February 1, 2000, A only
includes in income $8,881.83, the qualified stated interest
allocable to the period ($10,000) offset with bond premium
allocable to the period ($1,118.17). Under 1.1016-5(b), A's
basis in the bond is reduced by $1,118.17 on February 1, 2000.
Example 2. Alternative accrual periods--(i) Facts. The
facts are the same as in Example 1 of this paragraph (c) except
that A decides to use semiannual accrual periods ending on
February 1 and August 1 of each year.
(ii) Bond premium allocable to the first accrual period.
Based on the remaining payment schedule of the bond and A's basis
in the bond, A's yield is 7.92 percent, compounded semiannually.
The bond premium allocable to the accrual period ending on August
1, 1999, is the excess of the qualified stated interest allocable
to the period ($5,000) over the product of the adjusted
acquisition price at the beginning of the period ($110,000) and
A's yield, stated appropriately taking into account the length of
the accrual period (7.92 percent/2). Therefore, the bond premium
allocable to the accrual period is $645.29 ($5,000 - $4,354.71).
Although the accrual period ends on August 1, 1999, the qualified
stated interest of $5,000 is not taken into income until February
1, 2000, the date it is received. Likewise, the bond premium of
$645.29 is not taken into account until February 1, 2000. The
adjusted acquisition price of the bond on August 1, 1999, is
$109,354.71 (the adjusted acquisition price at the beginning of
the period ($110,000) less the bond premium allocable to the
period ($645.29)).
(iii) Bond premium allocable to the second accrual period.
Because the interval between payments of qualified stated
interest contains more than one accrual period, the adjusted
acquisition price at the beginning of the second accrual period
must be adjusted for the accrued but unpaid qualified stated
interest. Therefore, the adjusted acquisition price on August 1,
1999, is $114,354.71 ($109,354.71 + $5,000). The bond premium
allocable to the accrual period ending on February 1, 2000, is
the excess of the qualified stated interest allocable to the
period ($5,000) over the product of the adjusted acquisition
price at the beginning of the period ($114,354.71) and A's yield,
stated appropriately taking into account the length of the
accrual period (7.92 percent/2). Therefore, the bond premium
allocable to the accrual period is $472.88 ($5,000 - $4,527.12).
(iv) Premium used to offset interest. Although A receives
an interest payment of $10,000 on February 1, 2000, A only
includes in income $8,881.83, the qualified stated interest of
$10,000 ($5,000 allocable to the accrual period ending on August
1, 1999, and $5,000 allocable to the accrual period ending on
February 1, 2000) offset with bond premium of $1,118.17 ($645.29
allocable to the accrual period ending on August 1, 1999, and
$472.88 allocable to the accrual period ending on February 1,
2000). As indicated in Example 1 of this paragraph (c), this
same amount would be taken into income at the same time had A
used annual accrual periods.
Example 3. Holder uses accrual method of accounting--(i)
Facts. The facts are the same as in Example 1 of this paragraph
(c) except that A uses the accrual method of accounting. Thus,
for the accrual period ending on February 1, 2000, the qualified
stated interest allocable to the period is $10,000, and the bond
premium allocable to the period is $1,118.17. Because the
accrual period extends beyond the end of A's taxable year, A must
allocate these amounts between the two taxable years.
(ii) Amounts allocable to the first taxable year. The
qualified stated interest allocable to the first taxable year is
$9,166.67 ($10,000 x 11/12). The bond premium allocable to the
first taxable year is $1,024.99 ($1,118.17 x 11/12).
(iii) Premium used to offset interest. For 1999, A includes
in income $8,141.68, the qualified stated interest allocable to
the period ($9,166.67) offset with bond premium allocable to the
period ($1,024.99). Under 1.1016-5(b), A's basis in the bond is
reduced by $1,024.99 in 1999.
(iv) Amounts allocable to the next taxable year. The
remaining amounts of qualified stated interest and bond premium
allocable to the accrual period ending on February 1, 2000, are
taken into account for the taxable year ending on December 31,
2000.
Example 4. Tax-exempt obligation--(i) Facts. On January
15, 1999, C purchases for $120,000 a tax-exempt obligation
maturing on January 15, 2006, with a stated principal amount of
$100,000, payable at maturity. The obligation provides for
unconditional payments of interest of $9,000, payable on January
15 of each year. C uses the cash receipts and disbursements
method of accounting, and C decides to use annual accrual periods
ending on January 15 of each year.
(ii) Amount of bond premium. The interest payments on the
obligation are qualified stated interest. Therefore, the sum of
all amounts payable on the obligation (other than the interest
payments) is $100,000. Under 1.171-1, the amount of bond
premium is $20,000 ($120,000 - $100,000).
(iii) Bond premium allocable to the first accrual period.
Based on the remaining payment schedule of the obligation and C's
basis in the obligation, C's yield is 5.48 percent, compounded
annually. The bond premium allocable to the accrual period
ending on January 15, 2000, is the excess of the qualified stated
interest allocable to the period ($9,000) over the product of the
adjusted acquisition price at the beginning of the period
($120,000) and C's yield (5.48 percent, compounded annually).
Therefore, the bond premium allocable to the accrual period is
$2,420.55 ($9,000 - $6,579.45).
(iv) Premium used to offset interest. Although C receives
an interest payment of $9,000 on January 15, 2000, C only
receives tax-exempt interest income of $6,579.45, the qualified
stated interest allocable to the period ($9,000) offset with bond
premium allocable to the period ($2,420.55). Under 1.1016-5(b),
C's basis in the obligation is reduced by $2,420.55 on January
15, 2000.
1.171-3 Special rules for certain bonds.
(a) Variable rate debt instruments. Bond premium on a
variable rate debt instrument is determined by reference to the
stated redemption price at maturity of the equivalent fixed rate
debt instrument constructed for the variable rate debt
instrument. In addition, a holder allocates bond premium on a
variable rate debt instrument among the accrual periods by
reference to the equivalent fixed rate debt instrument. The
equivalent fixed rate debt instrument is determined as of the
date the variable rate debt instrument is acquired by the holder
and is constructed using the principles of 1.1275-5(e). See
paragraph (d) Example 1 of this section.
(b) Yield and remaining payment schedule of certain bonds
subject to contingencies--(1) Applicability. This paragraph (b)
provides rules that apply in determining the yield and remaining
payment schedule of certain bonds that provide for an alternative
payment schedule (or schedules) applicable upon the occurrence of
a contingency (or contingencies). This paragraph (b) applies,
however, only if the timing and amounts of the payments that
comprise each payment schedule are known as of the date the
holder acquires the bond (the acquisition date) and the bond is
subject to paragraph (b)(2), (3), or (4) of this section. A bond
does not provide for an alternative payment schedule merely
because there is a possibility of impairment of a payment (or
payments) by insolvency, default, or similar circumstances. See
1.1275-4 for the treatment of a bond that provides for a
contingency that is not described in this paragraph (b).
(2) Remaining payment schedule that is significantly more
likely than not to occur. If, based on all the facts and
circumstances as of the acquisition date, a single remaining
payment schedule for a bond is significantly more likely than not
to occur, this remaining payment schedule is used to determine
and amortize bond premium under 1.171-1 and 1.171-2.
(3) Mandatory sinking fund provision. Notwithstanding
paragraph (b)(2) of this section, if a bond is subject to a
mandatory sinking fund provision described in 1.1272-1(c)(3) and
the use and terms of the provision meet reasonable commercial
standards, the provision is ignored for purposes of determining
and amortizing bond premium under 1.171-1 and 1.171-2.
(4) Treatment of certain options--(i) Applicability.
Notwithstanding paragraphs (b)(2) and (3) of this section, the
rules of this paragraph (b)(4) determine the remaining payment
schedule of a bond that provides the holder or issuer with an
unconditional option or options, exercisable on one or more dates
during the remaining term of the bond, to alter the bond's
remaining payment schedule.
(ii) Operating rules. A holder determines the remaining
payment schedule of a bond by assuming that each option will (or
will not) be exercised under the following rules:
(A) Issuer options. The issuer of a tax-exempt obligation
is deemed to exercise or not exercise an option or combination of
options in the manner that minimizes the holder's yield on the
obligation. The issuer of a taxable bond is deemed to exercise
or not exercise an option or combination of options in the manner
that maximizes the holder's yield on the bond.
(B) Holder options. A holder is deemed to exercise or not
exercise an option or combination of options in the manner that
maximizes the holder's yield on the bond.
(C) Multiple options. If both the issuer and the holder
have options, the rules of paragraphs (b)(4)(ii)(A) and (B) of
this section are applied to the options in the order that they
may be exercised. Thus, the deemed exercise of one option may
eliminate other options that are later in time.
(5) Subsequent adjustments--(i) In general. Except as
provided in paragraph (b)(5)(ii) of this section, if a
contingency described in this paragraph (b) (including the
exercise of an option described in paragraph (b)(4) of this
section) actually occurs or does not occur, contrary to the
assumption made pursuant to this paragraph (b) (a change in
circumstances), then solely for purposes of section 171, the bond
is treated as retired and reacquired by the holder on the date of
the change in circumstances for an amount equal to the adjusted
acquisition price of the bond as of that date. If, however, the
change in circumstances results in a substantially
contemporaneous pro-rata prepayment as defined in
1.1275-2(f)(2), the pro-rata prepayment is treated as a payment
in retirement of a portion of the bond. See paragraph (d)
Example 2 of this section.
(ii) Bond premium deduction on the issuer's call of a
taxable bond. If a change in circumstances results from an
issuer's call of a taxable bond or a partial call that is a pro-
rata prepayment, the holder may deduct as bond premium an amount
equal to the excess, if any, of the adjusted acquisition price of
the bond over the greater of the amount received on redemption or
the amount payable on maturity.
(c) Remote and incidental contingencies. For purposes of
determining and amortizing bond premium, if a bond provides for a
contingency that is remote or incidental (within the meaning of
1.1275-2(h)), the contingency is taken into account under the
rules for remote and incidental contingencies in 1.1275-2(h).
(d) Examples. The following examples illustrate the rules
of this section. Each example assumes the holder uses the
calendar year as its taxable year and, except as otherwise
stated, has elected to amortize bond premium, effective for all
relevant taxable years. In addition, each example assumes a 30-
day month and 360-day year. Although, for purposes of
simplicity, the yield as stated is rounded to two decimal places,
the computations do not reflect this rounding convention.
Example 1. Variable rate debt instrument--(i) Facts. On
March 1, 1999, E purchases for $110,000 a taxable bond maturing
on March 1, 2007, with a stated principal amount of $100,000,
payable at maturity. The bond provides for unconditional
payments of interest on March 1 of each year based on the
percentage appreciation of a nationally-known commodity index.
On March 1, 1999, it is reasonably expected that the bond will
yield 12 percent, compounded annually. E uses the cash receipts
and disbursements method of accounting, and E decides to use
annual accrual periods ending on March 1 of each year. Assume
that the bond is a variable rate debt instrument under 1.1275-5.
(ii) Amount of bond premium. Because the bond is a variable
rate debt instrument, E determines and amortizes its bond premium
by reference to the equivalent fixed rate debt instrument
constructed for the bond as of March 1, 1999. Because the bond
provides for interest at a single objective rate that is
reasonably expected to yield 12 percent, compounded annually, the
equivalent fixed rate debt instrument for the bond is an eight-
year bond with a principal amount of $100,000, payable at
maturity. It provides for annual payments of interest of
$12,000. E's basis in the equivalent fixed rate debt instrument
is $110,000. The sum of all amounts payable on the equivalent
fixed rate debt instrument (other than payments of qualified
stated interest) is $100,000. Under 1.171-1, the amount of bond
premium is $10,000 ($110,000 - $100,000).
(iii) Bond premium allocable to each accrual period. E
allocates bond premium to the remaining accrual periods by
reference to the payment schedule on the equivalent fixed rate
debt instrument. Based on the payment schedule of the equivalent
fixed rate debt instrument and E's basis in the bond, E's yield
is 10.12 percent, compounded annually. The bond premium
allocable to the accrual period ending on March 1, 2000, is the
excess of the qualified stated interest allocable to the period
for the equivalent fixed rate debt instrument ($12,000) over the
product of the adjusted acquisition price at the beginning of the
period ($110,000) and E's yield (10.12 percent, compounded
annually). Therefore, the bond premium allocable to the accrual
period is $870.71 ($12,000 - $11,129.29). The bond premium
allocable to all the accrual periods is listed in the following
schedule:
Accrual period
ending
3/1/00
3/1/01
3/1/02
3/1/03
3/1/04
3/1/05
3/1/06
3/1/07 Adjusted
acquisition
price at beginning
of accrual period
$110,000.00
109,129.29
108,170.48
107,114.66
105,952.02
104,671.75
103,261.95
101,709.51
Premium allocable
to accrual period
$870.71
958.81
1,055.82
1,162.64
1,280.27
1,409.80
1,552.44
1,709.51
$10,000.00
(iv) Qualified stated interest for each accrual period.
Assume the bond actually pays the following amounts of qualified
stated interest:
Accrual period ending
3/1/00
3/1/01
3/1/02
3/1/03
3/1/04
3/1/05
3/1/06
3/1/07
Qualified stated interest
$15,000.00
0.00
0.00
10,000.00
8,000.00
12,000.00
15,000.00
8,500.00
(v) Premium used to offset interest. E's interest income
for each accrual period is determined by offsetting the qualified
stated interest allocable to the period with the bond premium
allocable to the period. For the accrual period ending on March
1, 2000, E includes in income $14,129.29, the qualified stated
interest allocable to the period ($15,000) offset with the bond
premium allocable to the period ($870.71). For the accrual
period ending on March 1, 2001, the bond premium allocable to the
period ($958.81) exceeds the qualified stated interest allocable
to the period ($0). Therefore, the excess of $958.81 ($958.81 -
$0) is carried forward to the next accrual period. For the next
accrual period, the qualified stated interest for the period is
insufficient to offset the bond premium allocable to the period
($1,055.82) and the amount carried forward from the prior period
($958.81). Thus, $2,014.63 ($1,055.82 + $958.81) is carried
forward to the accrual period ending on March 1, 2003, and
offsets qualified stated interest allocable to that period. The
amount E includes in income for each accrual period is shown in
the following schedule:
Accrual
period
ending
3/1/00
3/1/01
3/1/02
3/1/03
3/1/04
3/1/05
3/1/06
3/1/07
Qualified
stated
interest
$15,000.00
0.00
0.00
10,000.00
8,000.00
12,000.00
15,000.00
8,500.00 Premium
allocable
to accrual
period
$870.71
958.81
1,055.82
1,162.64
1,280.27
1,409.80
1,552.44
1,709.51
$10,000.00
Interest
income
$14,129.29
0.00
0.00
6,822.73
6,719.73
10,590.20
13,447.56
6,790.49
Premium
carryforward
958.81
2,014.63
Example 2. Partial call that results in a pro-rata
prepayment--(i) Facts. On April 1, 1999, M purchases for
$110,000 N's taxable bond maturing on April 1, 2006, with a
stated principal amount of $100,000, payable at maturity. The
bond provides for unconditional payments of interest of $10,000,
payable on April 1 of each year. N has the option to call all or
part of the bond on April 1, 2001, at a 5 percent premium over
the principal amount. M uses the cash receipts and disbursements
method of accounting.
(ii) Determination of yield and the remaining payment
schedule. M's yield determined without regard to the call option
is 8.07 percent, compounded annually. M's yield determined by
assuming N exercises its call option is 6.89 percent, compounded
annually. Under paragraph (b)(4)(ii)(A) of this section, it is
assumed N will not exercise the call option because exercising
the option would minimize M's yield. Thus, for purposes of
determining and amortizing bond premium, the bond is assumed to
be a seven-year bond with a single principal payment at maturity
of $100,000.
(iii) Amount of bond premium. The interest payments on the
bond are qualified stated interest. Therefore, the sum of all
amounts payable on the bond (other than the interest payments) is
$100,000. Under 1.171-1, the amount of bond premium is $10,000
($110,000 - $100,000).
(iv) Bond premium allocable to the first two accrual
periods. For the accrual period ending on April 1, 2000, M
includes in income $8,881.83, the qualified stated interest
allocable to the period ($10,000) offset with bond premium
allocable to the period ($1,118.17). The adjusted acquisition
price on April 1, 2000, is $108,881.83 ($110,000 - $1,118.17).
For the accrual period ending on April 1, 2001, M includes in
income $8,791.54, the qualified stated interest allocable to the
period ($10,000) offset with bond premium allocable to the period
($1,208.46). The adjusted acquisition price on April 1, 2001, is
$107,673.37 ($108,881.83 - $1,208.46).
(v) Partial call. Assume N calls one-half of M's bond for
$52,500 on April 1, 2001. Because it was assumed the call would
not be exercised, the call is a change in circumstances.
ob体育ever, the partial call is also a pro-rata prepayment within
the meaning of 1.1275-2(f)(2). As a result, the call is treated
as a retirement of one-half of the bond. Under paragraph
(b)(5)(ii) of this section, M may deduct $1,336.68, the excess of
its adjusted acquisition price in the retired portion of the bond
($107,673.37/2, or $53,836.68) over the amount received on
redemption ($52,500). M's adjusted basis in the portion of the
bond that remains outstanding is $53,836.68 ($107,673.37 -
$53,836.68).
1.171-4 Election to amortize bond premium on taxable bonds.
(a) Time and manner of making the election--(1) In general.
A holder makes the election to amortize bond premium by
offsetting interest income with bond premium in the holder's
timely filed federal income tax return for the first taxable year
to which the holder desires the election to apply. The holder
should attach to the return a statement that the holder is making
the election under this section.
(2) Coordination with OID election. If a holder makes an
election under 1.1272-3 for a bond with bond premium, the holder
is deemed to have made the election under this section.
(b) Scope of election. The election under this section
applies to all taxable bonds held during or after the taxable
year for which the election is made.
(c) Election to amortize made in a subsequent taxable
year--(1) In general. If a holder 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.
(2) Example. The following example illustrates the rule of
this paragraph (c).
Example--(i) Facts. On May 1, 1999, C purchases for
$130,000 a taxable bond maturing on May 1, 2006, with a stated
principal amount of $100,000, payable at maturity. The bond
provides for unconditional payments of interest of $15,000,
payable on May 1 of each year. C uses the cash receipts and
disbursements method of accounting and the calendar year as its
taxable year. C has not previously elected to amortize bond
premium, but does so for 2002.
(ii) Amount to amortize. C's basis for determining loss on
the sale or exchange of the bond is $130,000. Thus, under
1.171-1, the amount of bond premium is $30,000. Under 1.171-2,
if a bond premium election were in effect for the prior taxable
years, C would have amortized $3,257.44 of bond premium on May 1,
2000, and $3,551.68 of bond premium on May 1, 2001, based on
annual accrual periods ending on May 1. Thus, for 2002 and
future years to which the election applies, C may amortize only
$23,190.88 ($30,000 - $3,257.44 - $3,551.68).
(d) Revocation of election. The election under this section
may not be revoked unless approved by the Commissioner.
Par. 6. Section 1.171-5 is added to read as follows:
1.171-5 Effective date and transition rules.
(a) Effective date--(1) In general. This section and
1.171-1 through 1.171-4 apply to bonds acquired on or after the
date 60 days after the date final regulations are published in
the Federal Register. ob体育ever, if a holder makes the election
under 1.171-4 for the taxable year containing the date 60 days
after the date final regulations are published in the Federal
Register, this section and 1.171-1 through 1.171-4 apply to
bonds held on or after the first day of that taxable year.
(2) Transition rule for use of constant yield.
Notwithstanding paragraph (a)(1) of this section, 1.171-2(a)(3)
(providing that the bond premium allocable to an accrual period
is determined with reference to a constant yield) does not apply
to a bond issued before September 28, 1985.
(b) Coordination with existing election. A holder is deemed
to have made the election under 1.171-4 if the holder elected to
amortize bond premium under section 171 and that election is
effective on the date 60 days after the date final regulations
are published in the Federal Register.
(c) Accounting method changes--(1) Consent to change. A
holder required to change its method of accounting for bond
premium to comply with 1.171-1 through 1.171-3 must secure the
consent of the Commissioner in accordance with the requirements
of 1.446-1(e). Paragraph (c)(2) of this section provides the
Commissioner's automatic consent for certain changes. A holder
making the election does not need the Commissioner's consent.
(2) Automatic consent. The Commissioner grants consent for
a holder to change its method of accounting for bond premium with
respect to bonds to which 1.171-1 through 1.171-3 apply. The
consent granted by this paragraph (c)(2) applies provided--
(i) The holder elected to amortize bond premium under
section 171 for a taxable year prior to the taxable year
containing the date 60 days after the date final regulations are
published in the Federal Register and that election has not been
revoked;
(ii) The change is made for the first taxable year for which
the holder must account for a bond under 1.171-1 through
1.171-3; and
(iii) The holder attaches to its return for the taxable year
containing the change a statement that it has changed its method
of accounting under this section.
Par. 7. Section 1.1016-5 is amended by revising paragraph
(b) to read as follows:
1.1016-5 Miscellaneous adjustments to basis.
* * * * *
(b) Amortizable bond premium. A holder's basis in a bond is
reduced by the amount of bond premium used to offset qualified
stated interest income under 1.171-2. This reduction occurs
when the holder takes the qualified stated interest into account
under the holder's regular method of accounting. In addition, a
holder's basis in a taxable bond is reduced by the amount of bond
premium allowed as a deduction under 1.171-3(b)(5)(ii) (relating
to the issuer's call of a taxable bond).
* * * * *
1.1016-9 [Removed]
Par. 8. Section 1.1016-9 is removed.
Commissioner of Internal Revenue