---
kind: "section"
citation: "26 U.S.C. § 1277"
title: "26"
title_heading: "Internal Revenue Code"
number: "1277"
heading: "Deferral of interest deduction allocable to accrued market discount"
release: "119-102"
date: "2026-07-12"
url: "https://uscodex.org/usc/26/1277"
units:
  - "Subtitle A — Income Taxes"
  - "Chapter 1 — Normal Taxes and Surtaxes"
  - "Subchapter P — Capital Gains and Losses"
  - "Part V — Special Rules for Bonds and Other Debt Instruments"
  - "Subpart B — Market Discount on Bonds"
---

# §1277. Deferral of interest deduction allocable to accrued market discount

- (a) **General rule—** Except as otherwise provided in this section, the net direct [interest](/usc/26/856.md?p=f-1) expense with respect to any [market discount bond](/usc/26/1278.md?p=a-1-A) shall be allowed as a deduction for the taxable year only to the extent that such expense exceeds the portion of the [market discount](/usc/26/1278.md?p=a-2-A) allocable to the days during the taxable year on which such [bond](/usc/26/150.md?p=a-1) was held by the [taxpayer](/usc/26/1313.md?p=b) (as determined under the rules of [section 1276(b)](/usc/26/1276.md?p=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 general—** If—
      - (i) there is net [interest](/usc/26/856.md?p=f-1) income for any taxable year with respect to any [market discount bond](/usc/26/1278.md?p=a-1-A), and
      - (ii) the [taxpayer](/usc/26/1313.md?p=b) makes an election under this subparagraph with respect to such [bond](/usc/26/150.md?p=a-1),

      any disallowed [interest](/usc/26/856.md?p=f-1) expense with respect to such [bond](/usc/26/150.md?p=a-1) shall be treated as [interest](/usc/26/856.md?p=f-1) paid or accrued by the [taxpayer](/usc/26/1313.md?p=b) during such taxable year to the extent such disallowed [interest](/usc/26/856.md?p=f-1) expense does not exceed the net [interest](/usc/26/856.md?p=f-1) income with respect to such [bond](/usc/26/150.md?p=a-1).

    - (B) **Determination of disallowed interest expense—** For purposes of [subparagraph (A)](#b-1-A), the amount of the disallowed [interest](/usc/26/856.md?p=f-1) 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)](#b-1-A).
    - (C) **Net interest income—** For purposes of this paragraph, the term “net [interest](/usc/26/856.md?p=f-1) income” means the excess of the amount determined under [paragraph (2)](#c-2) of subsection (c) over the amount determined under [paragraph (1)](#c-1) of subsection (c).
  - (2) **Remainder of disallowed interest expense allowed for year of disposition—**
    - (A) **In general—** Except as otherwise provided in this paragraph, the amount of the disallowed [interest](/usc/26/856.md?p=f-1) expense with respect to any [market discount bond](/usc/26/1278.md?p=a-1-A) shall be treated as [interest](/usc/26/856.md?p=f-1) paid or accrued by the [taxpayer](/usc/26/1313.md?p=b) in the taxable year in which such [bond](/usc/26/150.md?p=a-1) is disposed of.
    - (B) **Nonrecognition transactions—** If any [market discount bond](/usc/26/1278.md?p=a-1-A) is disposed of in a nonrecognition transaction—
      - (i) the disallowed [interest](/usc/26/856.md?p=f-1) expense with respect to such [bond](/usc/26/150.md?p=a-1) shall be treated as [interest](/usc/26/856.md?p=f-1) paid or accrued in the year of [disposition](/usc/26/424.md?p=c-1) only to the extent of the amount of gain recognized on such [disposition](/usc/26/424.md?p=c-1), and
      - (ii) the disallowed [interest](/usc/26/856.md?p=f-1) expense with respect to such [property](/usc/26/317.md?p=a) (to the extent not so treated) shall be treated as disallowed [interest](/usc/26/856.md?p=f-1) expense—
        - (I) in the case of a transaction described in [section 1276(c)(1)](/usc/26/1276.md?p=c-1), of the transferee with respect to the transferred basis [property](/usc/26/317.md?p=a), or
        - (II) in the case of a transaction described in [section 1276(c)(2)](/usc/26/1276.md?p=c-2), with respect to the exchanged basis [property](/usc/26/317.md?p=a).
    - (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](/usc/26/856.md?p=f-1) expense shall not include any amount previously taken into account under [paragraph (1)](#b-1).
  - (3) **Disallowed interest expense—** For purposes of this subsection, the term “disallowed [interest](/usc/26/856.md?p=f-1) expense” means the aggregate amount disallowed under [subsection (a)](#a) with respect to the [market discount bond](/usc/26/1278.md?p=a-1-A).
- (c) **Net direct interest expense—** For purposes of this section, the term “net direct [interest](/usc/26/856.md?p=f-1) expense” means, with respect to any [market discount bond](/usc/26/1278.md?p=a-1-A), the excess (if any) of—
  - (1) the amount of [interest](/usc/26/856.md?p=f-1) paid or accrued during the taxable year on indebtedness which is incurred or continued to [purchase](/usc/26/1361.md?p=e-1-C) or carry such [bond](/usc/26/150.md?p=a-1), over
  - (2) the aggregate amount of [interest](/usc/26/856.md?p=f-1) (including [original issue discount](/usc/26/1278.md?p=a-5)) includible in gross income for the taxable year with respect to such [bond](/usc/26/150.md?p=a-1).

  In the case of any financial institution which is a bank (as defined in [section 585(a)(2)](/usc/26/585.md?p=a-2)), the [determination](/usc/26/1313.md?p=a) of whether [interest](/usc/26/856.md?p=f-1) is described in [paragraph (1)](#c-1) shall be made under principles similar to the principles of [section 291(e)(1)(B)(ii)](/usc/26/291.md?p=e-1-B-ii). Under rules similar to the rules of [section 265(a)(5)](/usc/26/265.md?p=a-5), short sale expenses shall be treated as [interest](/usc/26/856.md?p=f-1) for purposes of determining net direct [interest](/usc/26/856.md?p=f-1) expense.


## Source credit

(Added Pub. L. 98–369, div. A, title I, § 41(a), July 18, 1984, 98 Stat. 545; amended Pub. L. 99–514, title IX, §§ 901(d)(4)(F), § 902(e)(2), title XVIII, § 1899A(29)–(31), Oct. 22, 1986, 100 Stat. 2380, 2382, 2960; Pub. L. 100–647, title I, § 1018(u)(31), Nov. 10, 1988, 102 Stat. 3592; Pub. L. 103–66, title XIII, § 13206(b)(1)(B), Aug. 10, 1993, 107 Stat. 465; Pub. L. 104–188, title I, § 1616(b)(14), Aug. 20, 1996, 110 Stat. 1857.)

## Notes

### Editorial Notes

### Amendments

1996—Subsec. (c). Pub. L. 104–188 struck out “or to which section 593 applies” after “585(a)(2))” in closing provisions.

1993—Subsec. (d). Pub. L. 103–66 struck out heading and text of subsec. (d). Text read as follows: “In the case of a market discount bond issued on or before July 18, 1984, any gain recognized by the taxpayer on any disposition of such bond shall be treated as ordinary income to the extent the amount of such gain does not exceed the amount allowable with respect to such bond under subsection (b)(2) for the taxable year in which such bond is disposed of.”

1988—Subsec. (c). Pub. L. 100–647 inserted a closing parenthesis after “section 585(a)(2)”.

1986—Subsec. (b)(1)(C). Pub. L. 99–514, § 1899A(29), substituted “this paragraph” for “this paragaph”.

Subsec. (b)(2)(C). Pub. L. 99–514, § 1899A(30), substituted “paragraph (1)” for “paragraph 1” in heading.

Subsec. (c). Pub. L. 99–514, § 901(d)(4)(F), substituted “which is a bank (as defined in section 585(a)(2) or to which section 593 applies” for “to which section 585 or 593 applies”.

Pub. L. 99–514, § 902(e)(2), substituted “section 265(a)(5)” for “section 265(5)”.

Subsec. (d). Pub. L. 99–514, § 1899A(31), substituted “July 18, 1984” for “the date of the enactment of this section”.

### Statutory Notes and Related Subsidiaries

### Effective Date of 1996 Amendment

Amendment by Pub. L. 104–188 applicable to taxable years beginning after Dec. 31, 1995, see section 1616(c) of Pub. L. 104–188, set out as a note under section 593 of this title.

### Effective Date of 1993 Amendment

Amendment by Pub. L. 103–66 applicable to obligations purchased (within the meaning of section 1272(d)(1) [now 1272(c)(1)] of this title) after Apr. 30, 1993, see section 13206(b)(3) of Pub. L. 103–66, set out as a note under section 1276 of this title.

### Effective Date of 1988 Amendment

Amendment by Pub. L. 100–647 effective, except as otherwise provided, as if included in the provision of the Tax Reform Act of 1986, Pub. L. 99–514, to which such amendment relates, see section 1019(a) of Pub. L. 100–647, set out as a note under section 1 of this title.

### Effective Date of 1986 Amendment

Amendment by section 901(d)(4)(F) of Pub. L. 99–514 applicable to taxable years beginning after Dec. 31, 1986, see section 901(e) of Pub. L. 99–514, set out as a note under section 166 of this title.

Amendment by section 902(e)(2) of Pub. L. 99–514 applicable to taxable years ending after Dec. 31, 1986, with certain exceptions and qualifications, see section 902(f) of Pub. L. 99–514, set out as a note under section 265 of this title.

### Effective Date

Section applicable to taxable years ending after July 18, 1984, and applicable to obligations acquired after July 18, 1984, in taxable years ending after such date, see section 44 of Pub. L. 98–369, set out as a note under section 1271 of this title.

### Plan Amendments Not Required Until January 1, 1989

For provisions directing that if any amendments made by subtitle A or subtitle C of title XI [§§ 1101–1147 and 1171–1177] or title XVIII [§§ 1800–1899A] of Pub. L. 99–514 require an amendment to any plan, such plan amendment shall not be required to be made before the first plan year beginning on or after Jan. 1, 1989, see section 1140 of Pub. L. 99–514, as amended, set out as a note under section 401 of this title.