USC Subpart B

in effect

26 U.S.C. § 1276 Disposition gain representing accrued market discount treated as ordinary income

(a) Ordinary income(1) In generalExcept as otherwise provided in this section, gain on the disposition of any market discount bond shall be treated as ordinary income to the extent it does not exceed the accrued market discount on such bond. Such gain shall be recognized notwithstanding any other provision of this subtitle. (2) Dispositions other than sales, etc.For purposes of paragraph (1), a person disposing of any market discount bond in any transaction other than a sale, exchange, or involuntary conversion shall be treated as realizing an amount equal to the fair market value of the bond. (3) Treatment of partial principal payments(A) In generalAny partial principal payment on a market discount bond shall be included in gross income as ordinary income to the extent such payment does not exceed the accrued market discount on such bond. (B) AdjustmentIf subparagraph (A) applies to any partial principal payment on any market discount bond, for purposes of applying this section to any disposition of (or subsequent partial principal payment on) such bond, the amount of accrued market discount shall be reduced by the amount of such partial principal payment included in gross income under subparagraph (A). (4) Gain treated as interest for certain purposesExcept for purposes of sections 103, 871(a), 881, 1441, 1442, and 6049 (and such other provisions as may be specified in regulations), any amount treated as ordinary income under paragraph (1) or (3) shall be treated as interest for purposes of this title. (b) Accrued market discountFor purposes of this section—(1) Ratable accrualExcept as otherwise provided in this subsection or subsection (c), the accrued market discount on any bond shall be an amount which bears the same ratio to the market discount on such bond as—(A) the number of days which the taxpayer held the bond, bears to (B) the number of days after the date the taxpayer acquired the bond and up to (and including) the date of its maturity. (2) Election of accrual on basis of constant interest rate (in lieu of ratable accrual)(A) In generalAt the election of the taxpayer with respect to any bond, the accrued market discount on such bond shall be the aggregate amount which would have been includible in the gross income of the taxpayer under section 1272(a) (determined without regard to paragraph (2) thereof) with respect to such bond for all periods during which the bond was held by the taxpayer if such bond had been—(i) originally issued on the date on which such bond was acquired by the taxpayer, (ii) for an issue price equal to the basis of the taxpayer in such bond immediately after its acquisition. (B) Coordination where bond has original issue discountIn the case of any bond having original issue discount, for purposes of applying subparagraph (A)—(i) the stated redemption price at maturity of such bond shall be treated as equal to its revised issue price, and (ii) the determination of the portion of the original issue discount which would have been includible in the gross income of the taxpayer under section 1272(a) shall be made under regulations prescribed by the Secretary. (C) Election irrevocableAn election under subparagraph (A), once made with respect to any bond, shall be irrevocable. (3) Special rule where partial principal paymentsIn the case of a bond the principal of which may be paid in 2 or more payments, the amount of accrued market discount shall be determined under regulations prescribed by the Secretary. (c) Treatment of nonrecognition transactionsUnder regulations prescribed by the Secretary—(1) Transferred basis propertyIf a market discount bond is transferred in a nonrecognition transaction and such bond is transferred basis property in the hands of the transferee, for purposes of determining the amount of the accrued market discount with respect to the transferee—(A) the transferee shall be treated as having acquired the bond on the date on which it was acquired by the transferor for an amount equal to the basis of the transferor, and (B) proper adjustments shall be made for gain recognized by the transferor on such transfer (and for any original issue discount or market discount included in the gross income of the transferor). (2) Exchanged basis propertyIf any market discount bond is disposed of by the taxpayer in a nonrecognition transaction and paragraph (1) does not apply to such transaction, any accrued market discount determined with respect to the property disposed of to the extent not theretofore treated as ordinary income under subsection (a)—(A) shall be treated as accrued market discount with respect to the exchanged basis property received by the taxpayer in such transaction if such property is a market discount bond, and (B) shall be treated as ordinary income on the disposition of the exchanged basis property received by the taxpayer in such exchange if such property is not a market discount bond. (3) Paragraph (1) to apply to certain distributions by corporations or partnershipsFor purposes of paragraph (1), if the basis of any market discount bond in the hands of a transferee is determined under section 732(a), or 732(b), such property shall be treated as transferred basis property in the hands of such transferee. (d) Special rulesUnder regulations prescribed by the Secretary—(1) rules similar to the rules of subsection (b) of section 1245 shall apply for purposes of this section; except that—(A) paragraph (1) of such subsection shall not apply, (B) an exchange qualifying under section 354(a), 355(a), or 356(a) (determined without regard to subsection (a) of this section) shall be treated as an exchange described in paragraph (3) of such subsection, and (C) paragraph (3) of section 1245(b) shall be applied as if it did not contain a reference to section 351, and (2) appropriate adjustments shall be made to the basis of any property to reflect gain recognized under subsection (a).

26 U.S.C. § 1277 Deferral of interest deduction allocable to accrued market discount

(a) General ruleExcept as otherwise provided in this section, the net direct interest expense with respect to any market discount bond shall be allowed as a deduction for the taxable year only to the extent that such expense exceeds the portion of the market discount allocable to the days during the taxable year on which such bond was held by the taxpayer (as determined under the rules of section 1276(b)). (b) Disallowed deduction allowed for later years(1) Election to take into account in later year where net interest income from bond(A) In generalIf—(i) there is net interest income for any taxable year with respect to any market discount bond, and (ii) the taxpayer makes an election under this subparagraph with respect to such bond, any disallowed interest expense with respect to such bond shall be treated as interest paid or accrued by the taxpayer during such taxable year to the extent such disallowed interest expense does not exceed the net interest income with respect to such bond. (B) Determination of disallowed interest expenseFor purposes of subparagraph (A), the amount of the disallowed interest expense—(i) shall be determined as of the close of the preceding taxable year, and (ii) shall not include any amount previously taken into account under subparagraph (A). (C) Net interest incomeFor purposes of this paragraph, the term “net interest income” means the excess of the amount determined under paragraph (2) of subsection (c) over the amount determined under paragraph (1) of subsection (c). (2) Remainder of disallowed interest expense allowed for year of disposition(A) In generalExcept as otherwise provided in this paragraph, the amount of the disallowed interest expense with respect to any market discount bond shall be treated as interest paid or accrued by the taxpayer in the taxable year in which such bond is disposed of. (B) Nonrecognition transactionsIf any market discount bond is disposed of in a nonrecognition transaction—(i) the disallowed interest expense with respect to such bond shall be treated as interest paid or accrued in the year of disposition only to the extent of the amount of gain recognized on such disposition, and (ii) the disallowed interest expense with respect to such property (to the extent not so treated) shall be treated as disallowed interest expense—(I) in the case of a transaction described in section 1276(c)(1), of the transferee with respect to the transferred basis property, or (II) in the case of a transaction described in section 1276(c)(2), with respect to the exchanged basis property. (C) Disallowed interest expense reduced for amounts previously taken into account under paragraph (1)For purposes of this paragraph, the amount of the disallowed interest expense shall not include any amount previously taken into account under paragraph (1). (3) Disallowed interest expenseFor purposes of this subsection, the term “disallowed interest expense” means the aggregate amount disallowed under subsection (a) with respect to the market discount bond. (c) Net direct interest expenseFor purposes of this section, the term “net direct interest expense” means, with respect to any market discount bond, the excess (if any) of—(1) the amount of interest paid or accrued during the taxable year on indebtedness which is incurred or continued to purchase or carry such bond, over (2) the aggregate amount of interest (including original issue discount) includible in gross income for the taxable year with respect to such bond. In the case of any financial institution which is a bank (as defined in section 585(a)(2)), the determination of whether interest is described in paragraph (1) shall be made under principles similar to the principles of section 291(e)(1)(B)(ii). Under rules similar to the rules of section 265(a)(5), short sale expenses shall be treated as interest for purposes of determining net direct interest expense.

26 U.S.C. § 1278 Definitions and special rules

(a) In generalFor purposes of this part—(1) Market discount bond(A) In generalExcept as provided in subparagraph (B), the term “market discount bond” means any bond having market discount. (B) ExceptionsThe term “market discount bond” shall not include—(i) Short-term obligationsAny obligation with a fixed maturity date not exceeding 1 year from the date of issue. (ii) United States savings bondsAny United States savings bond. (iii) Installment obligationsAny installment obligation to which section 453B applies. (C) Section 1277 not applicable to tax-exempt obligationsFor purposes of section 1277, the term “market discount bond” shall not include any tax-exempt obligation (as defined in section 1275(a)(3)). (D) Treatment of bonds acquired at original issue(i) In generalExcept as otherwise provided in this subparagraph or in regulations, the term “market discount bond” shall not include any bond acquired by the taxpayer at its original issue. (ii) Treatment of bonds acquired for less than issue priceClause (i) shall not apply to any bond if—(I) the basis of the taxpayer in such bond is determined under section 1012, and (II) such basis is less than the issue price of such bond determined under subpart A of this part. (iii) Bonds acquired in certain reorganizationsClause (i) shall not apply to any bond issued pursuant to a plan of reorganization (within the meaning of section 368(a)(1)) in exchange for another bond having market discount. Solely for purposes of section 1276, the preceding sentence shall not apply if such other bond was issued on or before July 18, 1984 (the date of the enactment of section 1276) and if the bond issued pursuant to such plan of reorganization has the same term and the same interest rate as such other bond had. (iv) Treatment of certain transferred basis propertyFor purposes of clause (i), if the adjusted basis of any bond in the hands of the taxpayer is determined by reference to the adjusted basis of such bond in the hands of a person who acquired such bond at its original issue, such bond shall be treated as acquired by the taxpayer at its original issue. (2) Market discount(A) In generalThe term “market discount” means the excess (if any) of—(i) the stated redemption price of the bond at maturity, over (ii) the basis of such bond immediately after its acquisition by the taxpayer. (B) Coordination where bond has original issue discountIn the case of any bond having original issue discount, for purposes of subparagraph (A), the stated redemption price of such bond at maturity shall be treated as equal to its revised issue price. (C) De minimis ruleIf the market discount is less than ¼ of 1 percent of the stated redemption price of the bond at maturity multiplied by the number of complete years to maturity (after the taxpayer acquired the bond), then the market discount shall be considered to be zero. (3) BondThe term “bond” means any bond, debenture, note, certificate, or other evidence of indebtedness. (4) Revised issue priceThe term “revised issue price” means the sum of—(A) the issue price of the bond, and (B) the aggregate amount of the original issue discount includible in the gross income of all holders for periods before the acquisition of the bond by the taxpayer (determined without regard to section 1272(a)(7)) or, in the case of a tax-exempt obligation, the aggregate amount of the original issue discount which accrued in the manner provided by section 1272(a) (determined without regard to paragraph (7) thereof) during periods before the acquisition of the bond by the taxpayer. (5) Original issue discount, etc.The terms “original issue discount”, “stated redemption price at maturity”, and “issue price” have the respective meanings given such terms by subpart A of this part. (b) Election to include market discount currently(1) In generalIf the taxpayer makes an election under this subsection—(A) sections 1276 and 1277 shall not apply, and (B) market discount on any market discount bond shall be included in the gross income of the taxpayer for the taxable years to which it is attributable (as determined under the rules of subsection (b) of section 1276). Except for purposes of sections 103, 871(a), 881, 1441, 1442, and 6049 (and such other provisions as may be specified in regulations), any amount included in gross income under subparagraph (B) shall be treated as interest for purposes of this title. (2) Scope of electionAn election under this subsection shall apply to all market discount bonds acquired by the taxpayer on or after the 1st day of the 1st taxable year to which such election applies. (3) Period to which election appliesAn election under this subsection shall apply to the taxable year for which it is made and for all subsequent taxable years, unless the taxpayer secures the consent of the Secretary to the revocation of such election. (4) Basis adjustmentThe basis of any bond in the hands of the taxpayer shall be increased by the amount included in gross income pursuant to this subsection. (c) RegulationsThe Secretary shall prescribe such regulations as may be necessary to carry out the purposes of this subpart, including regulations providing proper adjustments in the case of a bond the principal of which may be paid in 2 or more payments.