---
kind: "range"
citation: "26 C.F.R. §§ 1.171-1–1.171-3"
title: "26"
from: "1.171-1"
to: "1.171-3"
count: 3
url: "https://uscodex.org/cfr/26/1.171-1..1.171-3"
---

# §1.171-1. Bond premium.

- (a) **Overview—**
  - (1) **In general.** This section and [§§ 1.171-2 through 1.171-5](/cfr/26/1.171-2..1.171-5.md) provide rules for the determination and amortization of bond premium by a holder. In general, a holder amortizes bond premium by offsetting the interest allocable to an accrual period with the premium allocable to that period. Bond premium is allocable to an accrual period based on a constant yield. The use of a constant yield to amortize bond premium is intended to generally conform the treatment of bond premium to the treatment of original issue discount under [sections 1271 through 1275](/cfr/26/1271..1275.md). Unless otherwise provided, the terms used in this section and [§§ 1.171-2 through 1.171-5](/cfr/26/1.171-2..1.171-5.md) have the same meaning as those terms in [sections 1271 through 1275](/cfr/26/1271..1275.md) and the corresponding regulations. Moreover, unless otherwise provided, the provisions of this section and [§§ 1.171-2 through 1.171-5](/cfr/26/1.171-2..1.171-5.md) apply in a manner consistent with those of [sections 1271 through 1275](/cfr/26/1271..1275.md) and the corresponding regulations. In addition, the anti-abuse rule in [§ 1.1275-2(g)](/cfr/26/1.1275-2.md?p=g) applies for purposes of this section and [§§ 1.171-2 through 1.171-5](/cfr/26/1.171-2..1.171-5.md).
  - (2) **Cross-references.** For rules dealing with the adjustments to a holder's basis to reflect the amortization of bond premium, see [§ 1.1016-5(b)](/cfr/26/1.1016-5.md?p=b). For rules dealing with the treatment of bond issuance premium by an issuer, see [§ 1.163-13](/cfr/26/1.163-13.md).
- (b) **Scope—**
  - (1) **In general.** Except as provided in [paragraph (b)(2)](#b-2) of this section and [§ 1.171-5](/cfr/26/1.171-5.md), this section and [§§ 1.171-2 through 1.171-4](/cfr/26/1.171-2..1.171-4.md) apply to any bond that, upon its acquisition by the holder, is held with bond premium. For purposes of this section and [§§ 1.171-2 through 1.171-5](/cfr/26/1.171-2..1.171-5.md), the term bond has the same meaning as the term debt instrument in [§ 1.1275-1(d)](/cfr/26/1.1275-1.md?p=d).
  - (2) **Exceptions.** This section and [§§ 1.171-2 through 1.171-5](/cfr/26/1.171-2..1.171-5.md) do not apply to—
    - (i) A bond described in [section 1272(a)(6)(C)](/cfr/26/1272.md?p=a-6-C) (regular interests in a REMIC, qualified mortgages held by a REMIC, and certain other debt instruments, or pools of debt instruments, with payments subject to acceleration);
    - (ii) A bond to which [§ 1.1275-4](/cfr/26/1.1275-4.md) applies (relating to certain debt instruments that provide for contingent payments);
    - (iii) A bond held by a holder that has made a [§ 1.1272-3](/cfr/26/1.1272-3.md) election with respect to the bond;
    - (iv) A bond that is stock in trade of the holder, a bond of a kind that would properly be included in the inventory of the holder if on hand at the close of the taxable year, or a bond held primarily for sale to customers in the ordinary course of the holder's trade or business; or
    - (v) A bond issued before September 28, 1985, unless the bond bears interest and was issued by a corporation or by a government or political subdivision thereof.
- (c) **General rule—**
  - (1) **Tax-exempt obligations.** A holder must amortize bond premium on a bond that is a tax-exempt obligation. See [§ 1.171-2(c)](/cfr/26/1.171-2.md?p=c) Example 4.
  - (2) **Taxable bonds.** A holder may elect to amortize bond premium on a taxable bond. Except as provided in [paragraph (c)(3)](#c-3) of this section, a taxable bond is any bond other than a tax-exempt obligation. See [§ 1.171-4](/cfr/26/1.171-4.md) for rules relating to the election to amortize bond premium on a taxable bond.
  - (3) **Bonds the interest on which is partially excludable.** For purposes of this section and [§§ 1.171-2 through 1.171-5](/cfr/26/1.171-2..1.171-5.md), a bond the interest on which is partially excludable from gross income is treated as two instruments, a tax-exempt obligation and a taxable bond. The holder's basis in the bond and each payment on the bond are allocated between the two instruments based on a reasonable method.
- (d) **Determination of bond premium—**
  - (1) **In general.** A holder acquires a bond at a premium if the holder's basis in the bond immediately after its acquisition by the holder exceeds the sum of all amounts payable on the bond after the acquisition date (other than payments of qualified stated interest). This excess is bond premium, which is amortizable under [§ 1.171-2](/cfr/26/1.171-2.md).
  - (2) **Additional rules for amounts payable on certain bonds.** Additional rules apply to determine the amounts payable on a variable rate debt instrument, an inflation-indexed debt instrument, a bond that provides for certain alternative payment schedules, and a bond that provides for remote or incidental contingencies. See [§ 1.171-3](/cfr/26/1.171-3.md).
- (e) **Basis.** A holder determines its basis in a bond under this [paragraph (e)](#e). This determination of basis applies only for purposes of this section and [§§ 1.171-2 through 1.171-5](/cfr/26/1.171-2..1.171-5.md). Because of the application of this [paragraph (e)](#e), the holder's basis in the bond for purposes of these sections may differ from the holder's basis for determining gain or loss on the sale or exchange of the bond.
  - (1) **Determination of basis—**
    - (i) **In general.** In general, the holder's basis in the bond is the holder's basis for determining loss on the sale or exchange of the bond.
    - (ii) **Bonds acquired in certain exchanges.** If the holder acquired the bond in exchange for other property (other than in a reorganization defined in [section 368](/cfr/26/368.md)) and the holder's basis in the bond is determined in whole or in part by reference to the holder's basis in the other property, the holder's basis in the bond may not exceed its fair market value immediately after the exchange. See [paragraph (f)](#f) Example 1 of this section. If the bond is acquired in a reorganization, see [section 171(b)(4)(B)](/cfr/26/171.md?p=b-4-B).
    - (iii) **Convertible bonds—**
      - (A) **General rule.** If the bond is a convertible bond, the holder's basis in the bond is reduced by an amount equal to the value of the conversion option. The value of the conversion option may be determined under any reasonable method. For example, the holder may determine the value of the conversion option by comparing the market price of the convertible bond to the market prices of similar bonds that do not have conversion options. See [paragraph (f)](#f) Example 2 of this section.
      - (B) **Convertible bonds acquired in certain exchanges.** If the bond is a convertible bond acquired in a transaction described in [paragraph (e)(1)(ii)](#e-1-ii) of this section, the holder's basis in the bond may not exceed its fair market value immediately after the exchange reduced by the value of the conversion option.
      - (C) **Definition of convertible bond.** A convertible bond is a bond that provides the holder with an option to convert the bond into stock of the issuer, stock or debt of a related party (within the meaning of section [267(b)](/cfr/26/267.md?p=b) or [707(b)(1)](/cfr/26/707.md?p=b-1)), or into cash or other property in an amount equal to the approximate value of such stock or debt. For bonds issued on or after February 5, 2013, the term stock in the preceding sentence means an equity interest in any entity that is classified, for Federal tax purposes, as either a partnership or a corporation.
  - (2) **Basis in bonds held by certain transferees.** Notwithstanding [paragraph (e)(1)](#e-1) of this section, if the bond is transferred basis property (as defined in [section 7701(a)(43)](/cfr/26/7701.md?p=a-43)) and the transferor had acquired the bond at a premium, the holder's basis in the bond is—
    - (i) The holder's basis for determining loss on the sale or exchange of the bond; reduced by
    - (ii) Any amounts that the transferor could not have amortized under this [paragraph (e)](#e) or under [§ 1.171-4(c)](/cfr/26/1.171-4.md?p=c), except to the extent that the holder's basis already reflects a reduction attributable to such nonamortizable amounts.
- (f) **Examples.** The following examples illustrate the rules of this section:

# §1.171-2. Amortization of bond premium.

- (a) **Offsetting qualified stated interest with premium—**
  - (1) **In general.** A holder amortizes bond premium by offsetting the qualified stated interest allocable to an accrual period with the bond premium allocable to the accrual period. This offset occurs when the holder takes the qualified stated interest into account under the holder's regular method of accounting.
  - (2) **Qualified stated interest allocable to an accrual period.** See [§ 1.446-2(b)](/cfr/26/1.446-2.md?p=b) to determine the accrual period to which qualified stated interest is allocable and to determine the accrual of qualified stated interest within an accrual period.
  - (3) **Bond premium allocable to an accrual period.** The bond premium allocable to an accrual period is determined under this [paragraph (a)(3)](#a-3). Within an accrual period, the bond premium allocable to the period accrues ratably.
    - (i) **Step one: Determine the holder's yield.** The holder's yield is the discount rate that, when used in computing the present value of all remaining payments to be made on the bond (including payments of qualified stated interest), produces an amount equal to the holder's basis in the bond as determined under [§ 1.171-1(e)](/cfr/26/1.171-1.md?p=e). For this purpose, the remaining payments include only payments to be made after the date the holder acquires the bond. The yield is calculated as of the date the holder acquires the bond, must be constant over the term of the bond, and must be calculated to at least two decimal places when expressed as a percentage.
    - (ii) **Step two: Determine the accrual periods.** A holder determines the accrual periods for the bond under the rules of [§ 1.1272-1(b)(1)(ii)](/cfr/26/1.1272-1.md?p=b-1-ii).
    - (iii) **Step three: Determine the bond premium allocable to the accrual period.** The bond premium allocable to an accrual period is the excess of the qualified stated interest allocable to the accrual period over the product of the holder's adjusted acquisition price (as defined in [paragraph (b)](#b) of this section) at the beginning of the accrual period and the holder's yield. In performing this calculation, the yield must be stated appropriately taking into account the length of the particular accrual period. Principles similar to those in [§ 1.1272-1(b)(4)](/cfr/26/1.1272-1.md?p=b-4) apply in determining the bond premium allocable to an accrual period.
  - (4) **Bond premium in excess of qualified stated interest—**
    - (i) **Taxable bonds—**
      - (A) **Bond premium deduction.** In the case of a taxable bond, 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)](/cfr/26/171.md?p=a-1) for the accrual period. However, the amount treated as a bond premium deduction 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. A deduction determined under this [paragraph (a)(4)(i)(A)](#a-4-i-A) is not subject to [section 67](/cfr/26/67.md) (the 2-percent floor on miscellaneous itemized deductions). See Example 1 of [§ 1.171-3(e)](/cfr/26/1.171-3.md?p=e).
      - (B) **Carryforward.** If the bond premium allocable to an accrual period exceeds the sum of the qualified stated interest allocable to the accrual period and the amount treated as a deduction for the accrual period under [paragraph (a)(4)(i)(A)](#a-4-i-A) of this section, the excess is carried forward to the next accrual period and is treated as bond premium allocable to that period.
      - (C) **Carryforward in holder's final accrual period—** (1) Bond premium deduction. If there is a bond premium carryforward determined under [paragraph (a)(4)(i)(B)](#a-4-i-B) of this section as of the end of the holder's accrual period in which the bond is sold, retired, or otherwise disposed of, the holder treats the amount of the carryforward as a bond premium deduction under [section 171(a)(1)](/cfr/26/171.md?p=a-1) for the holder's taxable year in which the sale, retirement, or other disposition occurs. For purposes of [§ 1.1016-5(b)](/cfr/26/1.1016-5.md?p=b), the holder's basis in the bond is reduced by the amount of bond premium allowed as a deduction under this paragraph (a)(4)(i)(C)(1).

        (2) Effective/applicability date. Notwithstanding [§ 1.171-5(a)(1)](/cfr/26/1.171-5.md?p=a-1), paragraph (a)(4)(i)(C)(1) of this section applies to a bond acquired on or after January 4, 2013. A taxpayer, however, may rely on paragraph (a)(4)(i)(C)(1) of this section for a bond acquired before that date.

    - (ii) **Tax-exempt obligations.** In the case of a tax-exempt obligation, 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. If a regulated investment company (RIC) within the meaning of [section 851](/cfr/26/851.md) has excess bond premium for an accrual period that would be a nondeductible loss under the prior sentence, the RIC must use this excess bond premium to reduce its tax-exempt interest income on other tax-exempt obligations held during the accrual period.
  - (5) **Additional rules for certain bonds.** Additional rules apply to determine the amortization of bond premium on a variable rate debt instrument, an inflation-indexed debt instrument, a bond that provides for certain alternative payment schedules, and a bond that provides for remote or incidental contingencies. See [§ 1.171-3](/cfr/26/1.171-3.md).
- (b) **Adjusted acquisition price.** The adjusted acquisition price of a bond at the beginning of the first accrual period is the holder's basis as determined under [§ 1.171-1(e)](/cfr/26/1.171-1.md?p=e). Thereafter, the adjusted acquisition price is the holder's basis in the bond decreased by—
  - (1) The amount of bond premium previously allocable under [paragraph (a)(3)](#a-3) of this section; and
  - (2) The amount of any payment previously made on the bond other than a payment of qualified stated interest.
- (c) **Examples.** The following examples illustrate the rules of this section. Each example assumes the holder uses the calendar year as its taxable year and has elected to amortize bond premium, effective for all relevant taxable years. In addition, each example assumes a 30-day month and 360-day year. Although, for purposes of simplicity, the yield as stated is rounded to two decimal places, the computations do not reflect this rounding convention. The examples are as follows:

# §1.171-3. Special rules for certain bonds.

- (a) **Variable rate debt instruments.** A holder determines bond premium on a variable rate debt instrument by reference to the stated redemption price at maturity of the equivalent fixed rate debt instrument constructed for the variable rate debt instrument. The holder also allocates any bond premium among the accrual periods by reference to the equivalent fixed rate debt instrument. The holder constructs the equivalent fixed rate debt instrument, as of the date the holder acquires the variable rate debt instrument, by using the principles of [§ 1.1275-5(e)](/cfr/26/1.1275-5.md?p=e). See [paragraph (e)](#e) Example 1 of this section.
- (b) **Inflation-indexed debt instruments.** A holder determines bond premium on an inflation-indexed debt instrument by assuming that there will be no inflation or deflation over the remaining term of the instrument. The holder also allocates any bond premium among the accrual periods by assuming that there will be no inflation or deflation over the remaining term of the instrument. The bond premium allocable to an accrual period offsets qualified stated interest allocable to the period. Notwithstanding [§ 1.171-2(a)(4)](/cfr/26/1.171-2.md?p=a-4), if the bond premium allocable to an accrual period exceeds the qualified stated interest allocable to the period, the excess is treated as a deflation adjustment under [§ 1.1275-7(f)(1)(i)](/cfr/26/1.1275-7.md?p=f-1-i). However, the rules in [§ 1.171-2(a)(4)(i)(C)](/cfr/26/1.171-2.md?p=a-4-i-C) apply to any remaining deflation adjustment attributable to bond premium as of the end of the holder's accrual period in which the bond is sold, retired, or otherwise disposed of. See [§ 1.1275-7](/cfr/26/1.1275-7.md) for other rules relating to inflation-indexed debt instruments.
- (c) **Yield and remaining payment schedule of certain bonds subject to contingencies—**
  - (1) **Applicability.** This [paragraph (c)](#c) provides rules that apply in determining the yield and remaining payment schedule of certain bonds that provide for an alternative payment schedule (or schedules) applicable upon the occurrence of a contingency (or contingencies). This [paragraph (c)](#c) applies, however, only if the timing and amounts of the payments that comprise each payment schedule are known as of the date the holder acquires the bond (the acquisition date) and the bond is subject to paragraph [(c)(2)](#c-2), [(3)](#c-3), or [(4)](#c-4) of this section. A bond does not provide for an alternative payment schedule merely because there is a possibility of impairment of a payment (or payments) by insolvency, default, or similar circumstances. See [§ 1.1275-4](/cfr/26/1.1275-4.md) for the treatment of a bond that provides for a contingency that is not described in this [paragraph (c)](#c).
  - (2) **Remaining payment schedule that is significantly more likely than not to occur.** If, based on all the facts and circumstances as of the acquisition date, a single remaining payment schedule for a bond is significantly more likely than not to occur, this remaining payment schedule is used to determine and amortize bond premium under §§ [1.171-1](/cfr/26/1.171-1.md) and [1.171-2](/cfr/26/1.171-2.md).
  - (3) **Mandatory sinking fund provision.** Notwithstanding [paragraph (c)(2)](#c-2) of this section, if a bond is subject to a mandatory sinking fund provision described in [§ 1.1272-1(c)(3)](/cfr/26/1.1272-1.md?p=c-3), the provision is ignored for purposes of determining and amortizing bond premium under §§ [1.171-1](/cfr/26/1.171-1.md) and [1.171-2](/cfr/26/1.171-2.md).
  - (4) **Treatment of certain options—**
    - (i) **Applicability.** Notwithstanding paragraphs [(c)(2)](#c-2) and [(3)](#c-3) of this section, the rules of this [paragraph (c)(4)](#c-4) determine the remaining payment schedule of a bond that provides the holder or issuer with an unconditional option or options, exercisable on one or more dates during the remaining term of the bond, to alter the bond's remaining payment schedule.
    - (ii) **Operating rules.** A holder determines the remaining payment schedule of a bond by assuming that each option will (or will not) be exercised under the following rules:
      - (A) **Issuer options.** In general, the issuer is deemed to exercise or not exercise an option or combination of options in the manner that minimizes the holder's yield on the obligation. However, the issuer of a taxable bond is deemed to exercise or not exercise a call option or combination of call options in the manner that maximizes the holder's yield on the bond.
      - (B) **Holder options.** A holder is deemed to exercise or not exercise an option or combination of options in the manner that maximizes the holder's yield on the bond.
      - (C) **Multiple options.** If both the issuer and the holder have options, the rules of paragraphs [(c)(4)(ii)(A)](#c-4-ii-A) and [(B)](#c-4-ii-B) of this section are applied to the options in the order that they may be exercised. Thus, the deemed exercise of one option may eliminate other options that are later in time.
  - (5) **Subsequent adjustments—**
    - (i) **In general.** Except as provided in [paragraph (c)(5)(ii)](#c-5-ii) of this section, if a contingency described in this [paragraph (c)](#c) (including the exercise of an option described in [paragraph (c)(4)](#c-4) of this section) actually occurs or does not occur, contrary to the assumption made pursuant to [paragraph (c)](#c) of this section (a change in circumstances), then solely for purposes of [section 171](/cfr/26/171.md), the bond is treated as retired and reacquired by the holder on the date of the change in circumstances for an amount equal to the adjusted acquisition price of the bond as of that date. If, however, the change in circumstances results in a substantially contemporaneous pro-rata prepayment as defined in [§ 1.1275-2(f)(2)](/cfr/26/1.1275-2.md?p=f-2), the pro-rata prepayment is treated as a payment in retirement of a portion of the bond. See [paragraph (e)](#e) Example 2 of this section.
    - (ii) **Bond premium deduction on the issuer's call of a taxable bond.** If a change in circumstances results from an issuer's call of a taxable bond or a partial call that is a pro-rata prepayment, the holder may deduct as bond premium an amount equal to the excess, if any, of the holder's adjusted acquisition price of the bond over the greater of—
      - (A) The amount received on redemption; and
      - (B) The amounts that would have been payable under the bond (other than payments of qualified stated interest) if no change in circumstances had occurred.
- (d) **Remote and incidental contingencies.** For purposes of determining and amortizing bond premium, if a bond provides for a contingency that is remote or incidental (within the meaning of [§ 1.1275-2(h)](/cfr/26/1.1275-2.md?p=h)), the holder takes the contingency into account under the rules for remote and incidental contingencies in [§ 1.1275-2(h)](/cfr/26/1.1275-2.md?p=h).
- (e) **Examples.** The following examples illustrate the rules of this section. Each example assumes the holder uses the calendar year as its taxable year and has elected to amortize bond premium, effective for all relevant taxable years. In addition, each example assumes a 30-day month and 360-day year. Although, for purposes of simplicity, the yield as stated is rounded to two decimal places, the computations do not reflect this rounding convention. The examples are as follows: