26 U.S.C. § 171 — Amortizable bond premium

(a) General rule: If you hold a bond (defined in subsection (d)), here is how the "amortizable bond premium" works: (1) Taxable bonds: If the bond's interest is not tax-exempt, you may deduct the amortizable bond premium each year. (2) Tax-exempt bonds: If the bond's interest is tax-exempt, you may not deduct any bond premium. (3) Cross reference: For how bond premium affects your basis, the value used to figure gain or loss, see section 1016(a)(5). (b) Amortizable bond premium: (1) Amount of bond premium: To figure your bond premium, start with your basis in the bond used to determine loss on sale. Compare it to the amount payable when the bond matures, or, if it produces a smaller premium before the call date, compare it to the amount payable on an earlier call date, for bonds under (a)(1). For bonds under (a)(2), always compare to the maturity or call amount. Then adjust for any amount of premium already used up before this section applied to you. A convertible bond's premium never includes value from its conversion feature. (2) Amount amortizable: Your amortizable bond premium for the year is the part of the premium that belongs to that year. If a bond described in (1)(B)(i) gets called during the year, add to that year's premium the amount by which your adjusted basis at the start of the year is more than what you received when the bond was redeemed, or the maturity amount if that is bigger. (3)(A) Method: Unless IRS regulations say otherwise, figure these amounts using your yield to maturity: use your basis for determining loss on sale, and compound the interest at the end of each accrual period, as defined in section 1272(a)(5). (3)(B) Special rule: If you used an earlier call date's payment amount to figure the premium before that date, treat the bond as if it matured on that date for that amount, then treat it as reissued that same day for the same amount. (4)(A) Bonds received in exchange for other property: If you got a bond by trading other property, and the bond's basis comes from that other property's basis, the bond's basis used for this section cannot be more than its fair market value right after the trade. This same limit applies to anyone later holding the bond whose basis also comes from that first person's basis. (4)(B) Exception for reorganizations: This basis limit does not apply if you traded one bond for another as part of a company "reorganization," defined in section 368. If part of your basis in the old bond was not counted toward bond premium because of this rule, that part also does not count for the new bond you receive. (c) Election for taxable bonds: (1) This section applies to bonds whose interest is taxable only if you choose to elect it. (2) You make this election following IRS regulations. Once you elect it for one bond, it applies to all your taxable bonds — the ones you already hold and any you get later — and it stays in effect for all future years, unless the IRS lets you revoke it under conditions the IRS sets. For bonds held by a common trust fund, defined in section 584(a), only the fund can make this election. For bonds held by an estate or trust, only the trustee can make it. (d) What counts as a "bond": A "bond" means any bond, debenture, note, certificate, or other evidence of debt. It does not include debt that is your business's stock in trade, debt that should be in your inventory at year-end, or debt you hold mainly to sell to customers in your regular business. (e) Treating premium as an offset to interest payments: Unless IRS regulations say otherwise, for a taxable bond: (1) split the bond premium among the interest payments using rules like those in (b)(3); and (2) instead of taking a deduction under (a), subtract the allocated premium from each interest payment to reduce it. Here, "taxable bond" means a bond whose interest is not tax-exempt. (f) Dealers in tax-exempt securities: For special rules that apply to securities dealers regarding premium on certain fully tax-exempt securities, see section 75.