26 U.S.C. § 1286 Tax treatment of stripped bonds
(a) Inclusion in income as if bond and coupons were original issue discount bondsIf any person purchases a stripped bond or a stripped coupon, then such bond or coupon while held by such purchaser (or by any other person whose basis is determined by reference to the basis in the hands of such purchaser) shall be treated for purposes of this part as a bond originally issued on the purchase date and having an original issue discount equal to the excess (if any) of—(1) the stated redemption price at maturity (or, in the case of coupon, the amount payable on the due date of such coupon), over (2) such bond’s or coupon’s ratable share of the purchase price. For purposes of paragraph (2), ratable shares shall be determined on the basis of their respective fair market values on the date of purchase.
(b) Tax treatment of person stripping bondFor purposes of this subtitle, if any person strips 1 or more coupons from a bond and disposes of the bond or such coupon—(1) such person shall include in gross income an amount equal to the sum of—(A) the interest accrued on such bond while held by such person and before the time such coupon or bond was disposed of (to the extent such interest has not theretofore been included in such person’s gross income), and (B) the accrued market discount on such bond determined as of the time such coupon or bond was disposed of (to the extent such discount has not theretofore been included in such person’s gross income), (2) the basis of the bond and coupons shall be increased by the amount included in gross income under paragraph (1), (3) the basis of the bond and coupons immediately before the disposition (as adjusted pursuant to paragraph (2)) shall be allocated among the items retained by such person and the items disposed of by such person on the basis of their respective fair market values, and (4) for purposes of subsection (a), such person shall be treated as having purchased on the date of such disposition each such item which he retains for an amount equal to the basis allocated to such item under paragraph (3). A rule similar to the rule of paragraph (4) shall apply in the case of any person whose basis in any bond or coupon is determined by reference to the basis of the person described in the preceding sentence.
(c) Special rules for tax-exempt obligations(1) In generalIn the case of any tax-exempt obligation (as defined in section 1275(a)(3)) from which 1 or more coupons have been stripped—(A) the amount of the original issue discount determined under subsection (a) with respect to any stripped bond or stripped coupon—(i) shall be treated as original issue discount on a tax-exempt obligation to the extent such discount does not exceed the tax-exempt portion of such discount, and (ii) shall be treated as original issue discount on an obligation which is not a tax-exempt obligation to the extent such discount exceeds the tax-exempt portion of such discount, (B) subsection (b)(1)(A) shall not apply, and (C) subsection (b)(2) shall be applied by increasing the basis of the bond or coupon by the sum of—(i) the interest accrued but not paid before such bond or coupon was disposed of (and not previously reflected in basis), plus (ii) the amount included in gross income under subsection (b)(1)(B). (2) Tax-exempt portionFor purposes of paragraph (1), the tax-exempt portion of the original issue discount determined under subsection (a) is the excess of—(A) the amount referred to in subsection (a)(1), over (B) an issue price which would produce a yield to maturity as of the purchase date equal to the lower of—(i) the coupon rate of interest on the obligation from which the coupons were separated, or (ii) the yield to maturity (on the basis of the purchase price) of the stripped obligation or coupon. The purchaser of any stripped obligation or coupon may elect to apply clause (i) by substituting “original yield to maturity of” for “coupon rate of interest on”.
(d) Definitions and special rulesFor purposes of this section—(1) BondThe term “bond” means a bond, debenture, note, or certificate or other evidence of indebtedness. (2) Stripped bondThe term “stripped bond” means a bond issued at any time with interest coupons where there is a separation in ownership between the bond and any coupon which has not yet become payable. (3) Stripped couponThe term “stripped coupon” means any coupon relating to a stripped bond. (4) Stated redemption price at maturityThe term “stated redemption price at maturity” has the meaning given such term by section 1273(a)(2). (5) CouponThe term “coupon” includes any right to receive interest on a bond (whether or not evidenced by a coupon). (6) PurchaseThe term “purchase” has the meaning given such term by section 1272(d)(1).11 See References in Text note below.
(e) Treatment of stripped interests in bond and preferred stock funds, etc.In the case of an account or entity substantially all of the assets of which consist of bonds, preferred stock, or a combination thereof, the Secretary may by regulations provide that rules similar to the rules of this section and section 305(e), as appropriate, shall apply to interests in such account or entity to which (but for this subsection) this section or section 305(e), as the case may be, would not apply.
(f) Regulation authorityThe Secretary may prescribe regulations providing that where, by reason of varying rates of interest, put or call options, or other circumstances, the tax treatment under this section does not accurately reflect the income of the holder of a stripped coupon or stripped bond, or of the person disposing of such bond or coupon, as the case may be, for any period, such treatment shall be modified to require that the proper amount of income be included for such period.