7646. How is premium on tax-exempt bonds amortized?Nuco Employeercline202014-10-01T14:15:00Z2014-10-01T14:15:00Z48024577Summit Business Media3810536914Site Map/Investments/Bonds/Government/Municipal BondsTaxFactsDefaultArticle2007-01-30T00:00:00Z121581127-00-tf2.xml1127.00;#1863;#0x010100C568DB52D9D0A14D9B2FDCC96666E9F2007948130EC3DB064584E219954237AF3900242457EFB8B24247815D688C526CD44D009C4E67E972694125ABDA91AC61F5E51FTax Facts 2How is premium on tax-exempt bonds amortized?13000.0000000000TaxFactsDefaultArticle2010-01-14T22:19:27ZSBMEDIA\moss-admin7646. How is premium on tax-exempt bonds amortized?Bond premium that must be amortized is the amount by which an individual’s tax basis for determining loss (adjusted for prior years’ amortization) exceeds the face amount of the bond at maturity (or earlier call date in the case of a callable bond).IRC Sec. 171(b)(1). (A taxpayer’s basis for determining loss can be lower than basis for determining gain, as in the case of a gift (see Q 521)).Under the regulations, which are generally effective for bonds acquired on or after March 2, 1998 (see Q 7638), a holder amortizes bond premium by offsetting qualified stated interest allocable to an accrual period with the bond premium allocable to the accrual period.Treas. Reg. §1.171-2. Bond premium is allocable to an accrual period based on a constant yield that is used to conform the treatment of bond premium to the treatment of original issue discount (see Q 7634).Treas. Reg. § 1.171-1. See also Treas. Reg. §1.171-2(c), Ex. 4.For the purpose of determining the amount amortizable, if the bond is acquired in an exchange for other property and the bond’s basis is determined (in whole or in part) by the basis of the property, the basis of the bond is not more than its fair market value immediately after the exchange.IRC Sec. 171(b)(4). This rule applies to exchanges occurring after May 6, 1986.Calculation of Amount AmortizedBonds Issued After September 27, 1985Except as provided in the regulations (see below), the annual amortizable amount is computed on the basis of the taxpayer’s yield to maturity by using the taxpayer’s basis in the bond (for purposes of determining loss) and by compounding at the close of each accrual period. (The accrual period is determined as discussed in Q 7634). If the amount payable on a call date that is earlier than maturity is used for purposes of determining the yield to maturity, the bond is treated as maturing on the call date and then as reissued on that call date for the amount payable on the call date.IRC Sec. 171(b)(3).Under the regulations generally in effect for bonds acquired on or after March 2, 1998, a holder amortizes bond premium under the same rules that apply to taxable bonds (see Q 7639); however, in the case of tax-exempt bonds, bond premium in excess of qualified stated interest is treated under a separate rule. If the bond premium allocable to an accrual period exceeds the qualified stated interest allocable to the accrual period, the excess is a nondeductible loss.Treas. Reg. §1.171-2(a)(4)(ii).See Q 7638 for an explanation of the effective date of the regulations under IRC Section 171.Bonds Issued on or Before September 27, 1985The amount of the premium allocable to each year may be determined under any reasonable method of amortization, but once an individual has used a method, he or she must consistently use the same method. (The Service has approved use of the “yield” method of amortizing bond premium).Rev. Rul. 82-10, 1982-1 CB 46. Instead of any other method, a taxpayer may use the straight line method set forth in the regulations. Under that method, the amount of premium that is allocable to each year is an amount that bears the same ratio to the bond premium as the number of months in the tax year the bond was held by the individual bears to the number of months from the beginning of the tax year (or, if the bond was acquired in the tax year, from the date of acquisition) to the date of maturity or to an earlier call date if appropriate. A fractional part of a month is counted only if it is more than one-half of a month and then it is counted as a month.Treas. Reg. §1.171-2(f). The regulations, as amended December 30, 1997, do not include the above rules.If the premium is solely a result of capitalized expenses (such as buying commissions), an individual using the straight line method provided in the regulations may amortize the capital expenses; if such expenses are a part of a larger premium, the individual must treat them as part of the premium, if he or she uses the straight line method.Treas. Reg. §1.171-2(d). The regulations, as amended December 30, 1997, do not include the above rules.Where there is more than one call date, the premium paid for a tax-exempt bond must be amortized to the earliest call date.Pacific Affiliate, Inc. v. Comm., 18 TC 1175 (1952), aff’d, 224 F.2d 578 (9th Cir. 1955), cert. den., 350 U.S. 967 (1956). If the bond is not called at that date, the premium is then amortized down to the next lower call price, and so on to maturity.Rev. Rul. 60-17, 1960-1 CB 124. The Service apparently reasons that because amortization is mandatory in the case of tax-exempt bonds, the entire premium must be subject to amortization.Example: A $100 bond is acquired at the time of issue for $125. The bond is callable in five years at $115 and in 10 years at $110. The individual may amortize $10 of the premium during the first five years and, if the bond is not then called, an additional $5 of premium during the next five years. If the bond is not called at the end of 10 years, the remaining $10 of premium must be amortized to maturity.