Read the regulations: T.D. 9609 [PDF 96 KB] and REG-140437-12 [PDF 73 KB]
Treasury inflation-protected securities issued at a premium
As noted in the preamble, temporary regulations were issued in December 2011 concerning the tax treatment of Treasury inflation- protected securities issued with more than a de minimis amount of premium. See TaxNewsFlash-United States: Regulations on tax treatment of “Treasury Inflation-Protected Securities” issued with more than de minimis amount of premium
With today’s release, the December 2011 temporary regulations are withdrawn, and the proposed regulations from 2011 are adopted “without substantive change” as final regulations that amend section 1.1275-7.
Bond premium carryforward
Under section 171 and Reg. section 1.171-2, an electing holder amortizes bond premium by offsetting qualified stated interest allocable to an accrual period with the bond premium allocable to the period.
If the bond premium allocable to an accrual period exceeds the qualified stated interest allocable to the accrual period, the excess is treated by the holder as a bond premium deduction under section 171(a)(1) for the accrual period. That deduction, however, is limited to the amount by which the holder’s total interest inclusions on the bond in prior accrual periods exceed the total amount treated by the holder as a bond premium deduction on the bond in prior accrual periods.
To the extent the bond premium deduction is limited, the excess is carried forward to the next accrual period and is treated as bond premium allocable to that period. Reg. section 1.171-2(a) (4).
Under Reg. section 1.1016-5(b), a holder’s basis in a bond is reduced by the amount of bond premium used to offset qualified stated interest on the bond and the amount of bond premium allowed as a deduction under section 171(a)(1). Thus, on the sale, retirement, or other disposition of the bond, the holder will realize a capital loss to the extent of any carried forward bond premium that has not been used to offset qualified stated interest on the bond or allowed as a deduction under section 171(a)(1). [Such a situation would occur if a zero coupon bond were purchased at a premium.]
The Treasury Department and IRS believe that the amount of bond premium carryforward is to be treated as a bond premium deduction under section 171(a)(1) rather than as a capital loss for the holder when the bond is sold, retired, or otherwise disposed of.
Thus, in addition, today’s temporary regulations provide that, upon the sale, retirement, or other disposition of a taxable bond, the holder treats the amount of any bond premium carryforward determined as of the end of the accrual period under Reg. section 1.171-2(a)(4)(i)(B) as a bond premium deduction under section 171(a) (1) for the holder’s tax year in which the sale, retirement, or other disposition occurs.
The regulations will be published in the Federal Register on Friday, January 4, 2013.