Publication 550
taxmap/pubs/p550-003.htm#en_us_publink10009982Words you may need to know (see Glossary)
A debt instrument, such as a bond, note, debenture, or other
evidence of indebtedness, that bears no interest or bears interest at a lower
than current market rate will usually be issued at less than its face amount.
This discount is, in effect, additional interest income. The following are some
types of discounted debt instruments.
- U.S. Treasury bonds.
- Corporate bonds.
- Municipal bonds.
- Certificates of deposit.
- Notes between individuals.
- Stripped bonds and coupons.
- Collateralized debt obligations (CDOs).
The discount on these instruments (except municipal bonds) is
taxable in most instances. The discount on municipal bonds generally is not
taxable (but see
State or Local Government Obligations, earlier, for exceptions). See also
REMICs, FASITs, and Other CDOs, later, for information about applying the rules discussed
in this section to the regular interest holder of a real estate mortgage
investment conduit, a financial asset securitization investment trust, or other
CDO.
OID is a form of interest. You generally include OID in your
income as it accrues over the term of the debt instrument, whether or not you
receive any payments from the issuer.
A debt instrument generally has OID when the instrument is issued
for a price that is less than its stated redemption price at maturity. OID is
the difference between the stated redemption price at maturity and the issue
price.
All debt instruments that pay no interest before maturity are
presumed to be issued at a discount. Zero coupon bonds are one example of these
instruments.
The OID accrual rules generally do not apply to short-term obligations
(those with a fixed maturity date of 1 year or less from date of issue). See
Discount on Short-Term Obligations, later.
For information about the sale of a debt instrument with OID,
see chapter 4.
taxmap/pubs/p550-003.htm#en_us_publink10009984You can treat the discount as zero if it is less than one-fourth
of 1% (.0025) of the stated redemption price at maturity multiplied by the
number of full years from the date of original issue to maturity. This small
discount is known as "de minimis" OID.
taxmap/pubs/p550-003.htm#en_us_publink10009985You bought a 10-year bond with a stated redemption price at maturity
of $1,000, issued at $980 with OID of $20. One-fourth of 1% of $1,000 (stated
redemption price) times 10 (the number of full years from the date of original
issue to maturity) equals $25. Because the $20 discount is less than $25, the
OID is treated as zero. (If you hold the bond at maturity, you will recognize
$20 ($1,000 − $980) of capital gain.)
taxmap/pubs/p550-003.htm#en_us_publink10009986The facts are the same as in
Example 1, except that the bond was issued at $950. The OID is $50. Because
the $50 discount is more than the $25 figured in
Example 1, you must include the OID in income as it accrues over the
term of the bond.
taxmap/pubs/p550-003.htm#en_us_publink10009987If you buy a debt instrument with
de minimis
OID at a premium, the discount is not includible in income. If you buy a debt
instrument with
de minimis
OID at a discount, the discount is reported under the market discount rules. See
Market Discount Bonds, later in this chapter.
The OID rules discussed here do not apply to the following debt
instruments.
- Tax-exempt obligations. (However, see
Stripped tax-exempt obligations, later.)
- U.S. savings bonds.
- Short-term debt instruments (those with a fixed maturity date
of not more than 1 year from the date of issue).
- Obligations issued by an individual before March 2, 1984.
- Loans between individuals, if all the following are true.
- The lender is not in the business of lending money.
- The amount of the loan, plus the amount of any outstanding
prior loans between the same individuals, is $10,000 or less.
- Avoiding any federal tax is not one of the principal purposes
of the loan.
The issuer of the debt instrument (or your broker, if you held
the instrument through a broker) should give you Form 1099-OID, Original Issue
Discount, or a similar statement, if the total OID for the calendar year is $10
or more. Form 1099-OID will show, in box 1, the amount of OID for the part of
the year that you held the bond. It also will show, in box 2, the stated
interest you must include in your income. A copy of Form 1099-OID will be sent
to the IRS. Do not file your copy with your return. Keep it for your records.
taxmap/pubs/p550-003.htm#en_us_publink10009990If you had OID for the year but did not receive a Form 1099-OID,
see the OID tables found at
http://www.irs.gov/formspubs/article/0,,id=213465,00.html, which list total OID on certain debt instruments and has information
that will help you figure OID. If your debt instrument is not listed, consult
the issuer for further information about the accrued OID for the year.
If someone else is the holder of record (the registered owner)
of an OID instrument belonging to you and receives a Form 1099-OID on your
behalf, that person must give you a Form 1099-OID.
If you receive a Form 1099-OID that includes amounts belonging
to another person, see
Nominee distributions under
How To Report Interest Income, later.
You must refigure the OID shown in box 1 or box 6 of Form 1099-OID
if either of the following apply.
- You bought the debt instrument after its original issue and
paid a premium or an acquisition premium.
- The debt instrument is a stripped bond or a stripped coupon
(including certain zero coupon instruments). See
Figuring OID under
Stripped Bonds and Coupons, later in this chapter.
See
Original issue discount (OID) adjustment under
How To Report Interest Income, later in this chapter, for information about reporting the
correct amount of OID.
You bought a debt instrument at a premium if its adjusted basis
immediately after purchase was greater than the total of all amounts payable on
the instrument after the purchase date, other than qualified stated interest.
If you bought an OID debt instrument at a premium, you generally
do not have to report any OID as ordinary income.
taxmap/pubs/p550-003.htm#en_us_publink10009994In general, this is stated interest unconditionally payable in
cash or property (other than debt instruments of the issuer) at least annually
at a fixed rate.
taxmap/pubs/p550-003.htm#en_us_publink10009995You bought a debt instrument at an acquisition premium if both
the following are true.
- You did not pay a premium.
- The instrument's adjusted basis immediately after purchase
(including purchase at original issue) was greater than its adjusted issue
price. This is the issue price plus the OID previously accrued, minus any
payment previously made on the instrument other than qualified stated interest.
Acquisition premium reduces the amount of OID includible in
your income. For information about figuring the correct amount of OID to include
in your income, see
Figuring OID on Long-Term Debt Instruments in Publication 1212.
If you disposed of a debt instrument or acquired it from another
holder during the year, see
Bonds Sold Between Interest Dates, earlier, for information about the treatment of periodic interest
that may be shown in box 2 of Form 1099-OID for that instrument.
The rules for reporting OID depend on the date the long-term
debt instrument was issued.
taxmap/pubs/p550-003.htm#en_us_publink10009998For these instruments, you do not report the OID until the year
you sell, exchange, or redeem the instrument. If a gain results and the
instrument is a capital asset, the amount of gain equal to the OID is ordinary
interest income. The rest is capital gain. If there is a loss on the sale of the
instrument, the entire loss is a capital loss and no reporting of OID is
required.
In general, the amount of gain that is ordinary interest income
equals the following amount:
| Number of full months | | Original |
| you held the instrument | × | Issue |
| Number of full months from date of | | Discount |
| original issue to date of maturity | | | |
If you hold these debt instruments as capital assets, you must
include a part of the discount in your gross income each year that you own the
instruments.
taxmap/pubs/p550-003.htm#en_us_publink100010000
Your basis in the instrument is increased by the amount of OID you include in
your gross income.
taxmap/pubs/p550-003.htm#en_us_publink100010001For these debt instruments, you report the total OID that applies
each year regardless of whether you hold that debt instrument as a capital
asset.
taxmap/pubs/p550-003.htm#en_us_publink100010002
Your basis in the instrument is increased by the amount of OID you include in
your gross income.
taxmap/pubs/p550-003.htm#en_us_publink100010003If you buy a CD with a maturity of more than 1 year, you must
include in income each year a part of the total interest due and report it in
the same manner as other OID.
This also applies to similar deposit arrangements with banks,
building and loan associations, etc., including:
- Time deposits,
- Bonus plans,
- Savings certificates,
- Deferred income certificates,
- Bonus savings certificates, and
- Growth savings certificates.
CDs issued after 1982 generally must be in registered form. Bearer
CDs are CDs not in registered form. They are not issued in the depositor's name
and are transferable from one individual to another.
Banks must provide the IRS and the person redeeming a bearer
CD with a Form 1099-INT.
taxmap/pubs/p550-003.htm#en_us_publink100010005This is an arrangement with a fixed maturity date in which you
make deposits on a schedule arranged between you and your bank. But there is no
actual or constructive receipt of interest until the fixed maturity date is
reached. For instance, you and your bank enter into an arrangement under which
you agree to deposit $100 each month for a period of 5 years. Interest will be
compounded twice a year at 71/2%, but payable only at the end of the 5-year period. You must
include a part of the interest in your income as OID each year. Each year the
bank must give you a Form 1099-OID to show you the amount you must include in
your income for the year.
taxmap/pubs/p550-003.htm#en_us_publink100010006If, before the maturity date, you redeem a deferred interest
account for less than its stated redemption price at maturity, you can deduct
OID that you previously included in income but did not receive.
taxmap/pubs/p550-003.htm#en_us_publink100010007If you renew a CD at maturity, it is treated as a redemption
and a purchase of a new certificate. This is true regardless of the terms of
renewal.
taxmap/pubs/p550-003.htm#en_us_publink100010008These certificates are subject to the OID rules. They are a form
of endowment contracts issued by insurance or investment companies for either a
lump-sum payment or periodic payments, with the face amount becoming payable on
the maturity date of the certificate.
In general, the difference between the face amount and the amount
you paid for the contract is OID. You must include a part of the OID in your
income over the term of the certificate.
The issuer must give you a statement on Form 1099-OID indicating
the amount you must include in your income each year.
taxmap/pubs/p550-003.htm#en_us_publink100010009If you hold an inflation-indexed debt instrument (other than
a series I U.S. savings bond), you must report as OID any increase in the
inflation-adjusted principal amount of the instrument that occurs while you held
the instrument during the year. In general, an inflation-indexed debt instrument
is a debt instrument on which the payments are adjusted for inflation and
deflation (such as Treasury Inflation-Protected Securities). You should receive
Form 1099-OID from the payer showing the amount you must report as OID and any
qualified stated interest paid to you during the year. For more information, see
Publication 1212.
taxmap/pubs/p550-003.htm#en_us_publink100010010If you strip one or more coupons from a bond and sell the bond
or the coupons, the bond and coupons are treated as separate debt instruments
issued with OID.
The holder of a stripped bond has the right to receive the principal
(redemption price) payment. The holder of a stripped coupon has the right to
receive interest on the bond.
Stripped bonds and stripped coupons include:
- Zero coupon instruments available through the Department of
the Treasury's Separate Trading of Registered Interest and Principal of
Securities (STRIPS) program and government-sponsored enterprises such as the
Resolution Funding Corporation and the Financing Corporation, and
- Instruments backed by U.S. Treasury securities that represent
ownership interests in those securities, such as obligations backed by U.S.
Treasury bonds offered primarily by brokerage firms.
If you strip coupons from a bond and sell the bond or coupons,
include in income the interest that accrued while you held the bond before the
date of sale, to the extent you did not previously include this interest in your
income. For an obligation acquired after October 22, 1986, you must also include
the market discount that accrued before the date of sale of the stripped bond
(or coupon) to the extent you did not previously include this discount in your
income.
Add the interest and market discount that you include in income
to the basis of the bond and coupons. Allocate this adjusted basis between the
items you keep and the items you sell, based on the fair market value of the
items. The difference between the sale price of the bond (or coupon) and the
allocated basis of the bond (or coupon) is your gain or loss from the sale.
Treat any item you keep as an OID bond originally issued and
bought by you on the sale date of the other items. If you keep the bond, treat
the amount of the redemption price of the bond that is more than the basis of
the bond as OID. If you keep the coupons, treat the amount payable on the
coupons that is more than the basis of the coupons as OID.
taxmap/pubs/p550-003.htm#en_us_publink100010012If you buy a stripped bond or stripped coupon, treat it as if
it were originally issued on the date you buy it. If you buy a stripped bond,
treat as OID any excess of the stated redemption price at maturity over your
purchase price. If you buy a stripped coupon, treat as OID any excess of the
amount payable on the due date of the coupon over your purchase price.
taxmap/pubs/p550-003.htm#en_us_publink100010013The rules for figuring OID on stripped bonds and stripped coupons
depend on the date the debt instruments were purchased, not the date issued.
You must refigure OID shown on the Form 1099-OID you receive
for a stripped bond or coupon. For information about figuring the correct amount
of OID on these instruments to include in your income, see
Figuring OID on Stripped Bonds and Coupons
in Publication 1212. However, owners of stripped bonds and coupons should not
rely on the OID shown in Section II of The OID tables (available at
http://www.irs.gov/formspubs/article/0,,id=213465,00.html) because the amounts listed in Section II for stripped bonds
or coupons are figured without reference to the date or price at which you
acquired them.
OID on stripped inflation-indexed debt instruments is figured
under the discount bond method. This method is described in Regulations section
1.1275-7(e).
taxmap/pubs/p550-003.htm#en_us_publink100010015You do not have to pay tax on OID on any stripped tax-exempt
bond or coupon you bought before June 11, 1987. However, if you acquired it
after October 22, 1986, you must accrue OID on it to determine its basis when
you dispose of it. See
Original issue discount (OID) on debt instruments under
Stocks and Bonds in chapter 4.
You may have to pay tax on part of the OID on stripped tax-exempt bonds or
coupons that you bought after June 10, 1987. For information on figuring the
taxable part, see
Tax-Exempt Bonds and Coupons under
Figuring OID on Stripped Bonds and Coupons in Publication 1212.
taxmap/pubs/p550-003.htm#en_us_publink100010016A market discount bond is any bond having market discount except:
- Short-term obligations (those with fixed maturity dates of
up to 1 year from the date of issue),
- Tax-exempt obligations you bought before May 1, 1993,
- U.S. savings bonds, and
- Certain installment obligations.
Market discount arises when the value of a debt obligation decreases
after its issue date. Generally, this is due to an increase in interest rates.
If you buy a bond on the secondary market, it may have market discount.
When you buy a market discount bond, you can choose to accrue
the market discount over the period you own the bond and include it in your
income currently as interest income. If you do not make this choice, the
following rules generally apply.
- You must treat any gain when you dispose of the bond as ordinary
interest income, up to the amount of the accrued market discount. See
Discounted Debt Instruments under
Capital Gains and Losses in chapter 4.
- You must treat any partial payment of principal on the bond
as ordinary interest income, up to the amount of the accrued market discount.
See
Partial principal payments, later in this discussion.
- If you borrow money to buy or carry the bond, your deduction
for interest paid on the debt is limited. See
Limit on interest deduction for market discount bonds under
When To Deduct Investment Interest in chapter 3.
Market discount is the amount of the stated redemption price
of a bond at maturity that is more than your basis in the bond immediately after
you acquire it. You treat market discount as zero if it is less than one-fourth
of 1% (.0025) of the stated redemption price of the bond multiplied by the
number of full years to maturity (after you acquire the bond).
If a market discount bond also has OID, the market discount is
the sum of the bond's issue price and the total OID includible in the gross
income of all holders (for a tax-exempt bond, the total OID that accrued) before
you acquired the bond, reduced by your basis in the bond immediately after you
acquired it.
taxmap/pubs/p550-003.htm#en_us_publink100010018Generally, a bond you acquired at original issue is not a market
discount bond. If your adjusted basis in a bond is determined by reference to
the adjusted basis of another person who acquired the bond at original issue,
you are also considered to have acquired it at original issue.
taxmap/pubs/p550-003.htm#en_us_publink100010019A bond you acquired at original issue can be a market discount
bond if either of the following is true.
- Your cost basis in the bond is less than the bond's issue
price.
- The bond is issued in exchange for a market discount bond
under a plan of reorganization. (This does not apply if the bond is issued in
exchange for a market discount bond issued before July 19, 1984, and the terms
and interest rates of both bonds are the same.)
The accrued market discount is figured in one of two ways.
taxmap/pubs/p550-003.htm#en_us_publink100010021Treat the market discount as accruing in equal daily installments
during the period you hold the bond. Figure the daily installments by dividing
the market discount by the number of days after the date you acquired the bond,
up to and including its maturity date. Multiply the daily installments by the
number of days you held the bond to figure your accrued market discount.
taxmap/pubs/p550-003.htm#en_us_publink100010022Instead of using the ratable accrual method, you can choose to
figure the accrued discount using a constant interest rate (the constant yield
method). Make this choice by attaching to your timely filed return a statement
identifying the bond and stating that you are making a constant interest rate
election. The choice takes effect on the date you acquired the bond. If you
choose to use this method for any bond, you cannot change your choice for that
bond.
For information about using the constant yield method, see
Constant yield method under
Debt Instruments Issued After 1984
in Publication 1212. To use this method to figure market discount (instead of
OID), treat the bond as having been issued on the date you acquired it. Treat
the amount of your basis (immediately after you acquired the bond) as the issue
price. Then apply the formula shown in Publication 1212.
taxmap/pubs/p550-003.htm#en_us_publink100010023You can make this choice if you have not revoked a prior choice
to include market discount in income currently within the last 5 calendar years.
Make the choice by attaching to your timely filed return a statement in which
you:
- State that you have included market discount in your gross
income for the year under section 1278(b) of the Internal Revenue Code, and
- Describe the method you used to figure the accrued market
discount for the year.
Once you make this choice, it will apply to all market discount
bonds you acquire during the tax year and in later tax years. You cannot revoke
your choice without the consent of the IRS. For information on how to revoke
your choice, see section 32 of the Appendix to Revenue Procedure 2008-52 in
Internal Revenue Bulletin 2008-36. You can find this revenue procedure at
www.irs.gov/irb/2008-36_IRB/ar09.html.
You increase the basis of your bonds by the amount of market
discount you include in your income.
taxmap/pubs/p550-003.htm#en_us_publink100010025If you receive a partial payment of principal on a market discount
bond you acquired after October 22, 1986, and you did not choose to include the
discount in income currently, you must treat the payment as ordinary interest
income up to the amount of the bond's accrued market discount. Reduce the amount
of accrued market discount reportable as interest at disposition by that amount.
There are three methods you can use to figure accrued market
discount for this purpose.
- On the basis of the constant yield method, described earlier.
- In proportion to the accrual of OID for any accrual period,
if the debt instrument has OID.
- In proportion to the amount of stated interest paid in the
accrual period, if the debt instrument has no OID.
Under method (2) above, figure accrued market discount for a period by
multiplying the total remaining market discount by a fraction. The numerator
(top part) of the fraction is the OID for the period, and the denominator
(bottom part) is the total remaining OID at the beginning of the period.
Under method (3) above, figure accrued market discount for a
period by multiplying the total remaining market discount by a fraction. The
numerator is the stated interest paid in the accrual period, and the denominator
is the total stated interest remaining to be paid at the beginning of the
accrual period.
taxmap/pubs/p550-003.htm#en_us_publink100010026When you buy a short-term obligation (one with a fixed maturity
date of 1 year or less from the date of issue), other than a tax-exempt
obligation, you can generally choose to include any discount and interest
payable on the obligation in income currently. If you do not make this choice,
the following rules generally apply.
- You must treat any gain when you sell, exchange, or redeem
the obligation as ordinary income, up to the amount of the ratable share of the
discount. See
Discounted Debt Instruments under
Capital Gains and Losses in chapter 4.
- If you borrow money to buy or carry the obligation, your deduction
for interest paid on the debt is limited. See
Limit on interest deduction for short-term obligations under
When To Deduct Investment Interest in chapter 3.
You must include any discount or interest in current income as
it accrues for any short-term obligation (other than a tax-exempt obligation)
that is:
- Held by an accrual-basis taxpayer;
- Held primarily for sale to customers in the ordinary course
of your trade or business;
- Held by a bank, regulated investment company, or common trust
fund;
- Held by certain pass-through entities;
- Identified as part of a hedging transaction; or
- A stripped bond or stripped coupon held by the person who
stripped the bond or coupon (or by any other person whose basis in the
obligation is determined by reference to the basis in the hands of the person
who stripped the bond or coupon).
Increase the basis of your obligation by the amount of discount
you include in income currently.
taxmap/pubs/p550-003.htm#en_us_publink100010029Figure the accrued discount by using either the ratable accrual
method or the constant yield method discussed previously in
Accrued market discount under
Market Discount Bonds, earlier.
For an obligation described above that is a short-term government
obligation, the amount you include in your income for the current year is the
accrued acquisition discount, if any, plus any other accrued interest payable on
the obligation. The acquisition discount is the stated redemption price at
maturity minus your basis.
If you choose to use the constant yield method to figure accrued
acquisition discount, treat the cost of acquiring the obligation as the issue
price. If you choose to use this method, you cannot change your choice.
taxmap/pubs/p550-003.htm#en_us_publink100010031For an obligation listed above that is not a government obligation,
the amount you include in your income for the current year is the accrued OID,
if any, plus any other accrued interest payable. If you choose the constant
yield method to figure accrued OID, apply it by using the obligation's issue
price.
taxmap/pubs/p550-003.htm#en_us_publink100010032You can choose to report accrued acquisition discount (defined
earlier under
Government obligations) rather than accrued OID on these short-term obligations. Your
choice will apply to the year for which it is made and to all later years and
cannot be changed without the consent of the IRS.
You must make your choice by the due date of your return, including
extensions, for the first year for which you are making the choice. Attach a
statement to your return or amended return indicating:
- Your name, address, and social security number;
- The choice you are making and that it is being made under
section 1283(c)(2) of the Internal Revenue Code;
- The period for which the choice is being made and the obligation
to which it applies; and
- Any other information necessary to show you are entitled to
make this choice.
If you acquire short-term discount obligations that are not subject
to the rules for current inclusion in income of the accrued discount or other
interest, you can choose to have those rules apply. This choice applies to all
short-term obligations you acquire during the year and in all later years. You
cannot change this choice without the consent of the IRS.
The procedures to use in making this choice are the same as those
described for choosing to include acquisition discount instead of OID on
nongovernment obligations in current income. However, you should indicate that
you are making the choice under section 1282(b)(2) of the Internal Revenue Code.
Also see the following discussion. If you make the election to report all
interest currently as OID, you must use the constant yield method.
taxmap/pubs/p550-003.htm#en_us_publink100010034
Generally, you can elect to treat all interest on a debt instrument acquired
during the tax year as OID and include it in income currently. For purposes of
this election, interest includes stated interest, acquisition discount, OID,
de minimis OID, market discount,
de minimis
market discount, and unstated interest as adjusted by any amortizable bond
premium or acquisition premium. See Regulations section 1.1272-3.
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