An amortizable bond premium occurs when you pay more than a bond’s face value, and the extra amount can be spread out over the life of the bond. Amortizing bond premium is generally optional but affects how bond interest income is reported.
Why It Happens
Investors pay a premium when a bond offers a higher interest rate than current market rates. The premium reflects the bond’s added value—but for tax purposes, it can be gradually deducted.
Tax Treatment
- Taxable Bonds (e.g., corporate or U.S. Treasury bonds):
- You can elect to amortize the premium.
- The amortized amount reduces taxable interest income each year.
- You cannot deduct the premium as a lump sum.
- Tax-Exempt Bonds (e.g., municipal bonds):
- You must amortize the premium.
- The amortized amount does not reduce taxable income, but it lowers the bond’s cost basis, affecting gain/loss when sold.
Example:
You buy a bond for $1,100 with a face value of $1,000, and it matures in 10 years.
- The $100 premium is amortized over 10 years.
- Each year, you reduce your taxable interest income by $10 (for taxable bonds).
How to Report
- Use Form 1099-INT or Form 1099-OID to report interest income.
- Keep track of amortization using Form 8949 or your own records.
- You may need to make an election under IRC Section 171 to amortize the premium.