Publication 550

Previous Page | Table of Contents | Index | Next Page |

## Bond Premium Amortization(p34) |

If you pay a premium to buy a bond, the premium is part of your
basis in the bond. If the bond yields taxable interest, you can choose to
amortize the premium. This generally means that each year, over the life of the
bond, you use a part of the premium to reduce the amount of interest includible
in your income. If you make this choice, you must reduce your basis in the bond
by the amortization for the year.

If the bond yields tax-exempt interest, you must amortize the
premium. This amortized amount is not deductible in determining taxable income.
However, each year you must reduce your basis in the bond (and tax-exempt
interest otherwise reportable on Form 1040, line 8b) by the amortization for the
year.

taxmap/pubs/p550-015.htm#en_us_publink100010251## Bond premium.(p34) |

Bond premium is the amount by which your basis in the bond right
after you get it is more than the total of all amounts payable on the bond after
you get it (other than payments of qualified stated interest). For example, a
bond with a maturity value of $1,000 generally would have a $50 premium if you
buy it for $1,050.

taxmap/pubs/p550-015.htm#en_us_publink100010252Basis.(p34) |

In general, your basis for figuring bond premium amortization
is the same as your basis for figuring any loss on the sale of the bond.
However, you may need to use a different basis for:
See Regulations section 1.171-1(e).

taxmap/pubs/p550-015.htm#en_us_publink100010253## Dealers.(p35) |

A dealer in taxable bonds (or anyone who holds them mainly for
sale to customers in the ordinary course of a trade or business or who would
properly include bonds in inventory at the close of the tax year) cannot claim a
deduction for amortizable bond premium.

See section 75 of the Internal Revenue Code for the treatment
of bond premium by a dealer in tax-exempt bonds.

taxmap/pubs/p550-015.htm#en_us_publink100010254## How To Figure |

For bonds issued after September 27, 1985, you must amortize
bond premium using a constant yield method on the basis of the bond's yield to
maturity, determined by using the bond's basis and compounding at the close of
each accrual period.

taxmap/pubs/p550-015.htm#en_us_publink100010255## Constant yield method.(p35) |

Figure the bond premium amortization for each accrual period
as follows.

taxmap/pubs/p550-015.htm#en_us_publink100010256Step 1: determine your yield.(p35) |

Your yield is the discount rate that, when used in figuring the
present value of all remaining payments to be made on the bond (including
payments of qualified stated interest), produces an amount equal to your basis
in the bond. Figure the yield as of the date you got the bond. It must be
constant over the term of the bond and must be figured to at least two decimal
places when expressed as a percentage.

If you do not know the yield, consult your broker or tax advisor.
Databases available to them are likely to show the yield at the date of
purchase.

taxmap/pubs/p550-015.htm#en_us_publink100010257Step 2: determine the accrual periods.(p35) |

You can choose the accrual periods to use. They may be of any
length and may vary in length over the term of the bond, but each accrual period
can be no longer than 1 year and each scheduled payment of principal or interest
must occur either on the first or the final day of an accrual period. The
computation is simplest if accrual periods are the same as the intervals between
interest payment dates.

taxmap/pubs/p550-015.htm#en_us_publink100010258Step 3: determine the bond premium for the accrual period.(p35) |

To do this, multiply your adjusted acquisition price at the beginning
of the accrual period by your yield. Then subtract the result from the qualified
stated interest for the period.

Your adjusted acquisition price at the beginning of the first
accrual period is the same as your basis. After that, it is your basis decreased
by the amount of bond premium amortized for earlier periods and the amount of
any payment previously made on the bond other than a payment of qualified stated
interest.

taxmap/pubs/p550-015.htm#en_us_publink100010259On February 1, 2009, you bought a taxable bond for $110,000.
The bond has a stated principal amount of $100,000, payable at maturity on
February 1, 2016, making your premium $10,000 ($110,000 − $100,000). The
bond pays qualified stated interest of $10,000 on February 1 of each year. Your
yield is 8.07439% compounded annually. You choose to use annual accrual periods
ending on February 1 of each year. To find your bond premium amortization for
the accrual period ending on February 1, 2010, you multiply the adjusted
acquisition price at the beginning of the period ($110,000) by your yield. When
you subtract the result ($8,881.83) from the qualified stated interest for the
period ($10,000), you find that your bond premium amortization for the period is
$1,118.17.

taxmap/pubs/p550-015.htm#en_us_publink100010260Special rules.(p35) |

For special rules that apply to variable rate bonds, inflation-indexed
bonds, and bonds that provide for alternative payment schedules or remote or
incidental contingencies, see Regulations section 1.171-3.

taxmap/pubs/p550-015.htm#en_us_publink100010261## Bonds Issued Before |

For these bonds, you can amortize bond premium using any reasonable
method. Reasonable methods include:

taxmap/pubs/p550-015.htm#en_us_publink100010262## Straight-line method.(p35) |

Under this method, the amount of your bond premium amortization
is the same each month. Divide the number of months you held the bond during the
year by the number of months from the beginning of the tax year (or, if later,
the date of acquisition) to the date of maturity or earlier call date. Then
multiply the result by the bond premium (reduced by any bond premium
amortization claimed in earlier years). This gives you your bond premium
amortization for the year.

taxmap/pubs/p550-015.htm#en_us_publink100010263## Revenue Ruling 82-10 method.(p35) |

Under this method, the amount of your bond premium amortization
increases each month over the life of the bond. This method is explained in
Revenue Ruling 82-10, 1982-1 C.B. 46.

taxmap/pubs/p550-015.htm#en_us_publink100010264## Choosing To Amortize(p35) |

You choose to amortize the premium on taxable bonds by reporting
the amortization for the year on your income tax return for the first tax year
you want the choice to apply. You should attach a statement to your return that
you are making this choice under section 171. See
*How To Report Amortization*, next.

This choice is binding for the year you make it and for later
tax years. It applies to all taxable bonds you own in the year you make the
choice and also to those you acquire in later years.

You can change your decision to amortize bond premium only with the written
approval of the IRS. To request approval, use Form 3115, Application for Change
in Accounting Method. For more information on requesting approval, see section 5
of the Appendix to Revenue Procedure 2008-52 in Internal Revenue Bulletin
2008-36. You can find Revenue Procedure 2008-52 at
www.irs.gov/irb/2008-36_IRB/ar09.html.

taxmap/pubs/p550-015.htm#en_us_publink100010265## How To Report |

Subtract the bond premium amortization from your interest income
from these bonds.

Report the bond's interest on Schedule B (Form 1040A or 1040),
line 1. Several lines above line 2, put a subtotal of all interest listed on
line 1. Below this subtotal, print "ABP Adjustment," and the amortization
amount. Subtract this amount from the subtotal, and enter the result on line 2.

taxmap/pubs/p550-015.htm#en_us_publink100010266## Bond premium amortization more than interest.(p35) |

If the amount of your bond premium amortization for an accrual
period is more than the qualified stated interest for the period, you can deduct
the difference as a miscellaneous itemized deduction on Schedule A (Form 1040),
line 28.

But your deduction is limited to the amount by which your total interest
inclusions on the bond in prior accrual periods is more than your total bond
premium deductions on the bond in prior periods. Any amount you cannot deduct
because of this limit can be carried forward to the next accrual period.

taxmap/pubs/p550-015.htm#en_us_publink100010267## Pre-1998 election to amortize bond premium.(p35) |

Generally, if you first elected to amortize bond premium before
1998, the above treatment of the premium does not apply to bonds you acquired
before 1988.

taxmap/pubs/p550-015.htm#en_us_publink100010268Bonds acquired before October 23, 1986.(p35) |

The amortization of the premium on these bonds is a miscellaneous
itemized deduction not subject to the 2%-of-adjusted-gross-income limit.

taxmap/pubs/p550-015.htm#en_us_publink100010269Bonds acquired after October 22, 1986, but before 1988.(p35) |

The amortization of the premium on these bonds is investment interest expense
subject to the investment interest limit, unless you choose to treat it as an
offset to interest income on the bond.

Previous Page | Table of Contents | Top of Page | Index | Next Page |