Bond premium is the amount by which your basis in a bond right after you get it is more than the total of all amounts payable on the bond after you get it (other than payments of qualified stated interest).

The term "bond," as used in this discussion, means any interest-bearing bond, debenture, note, or certificate or other evidence of debt. The term does not include any obligation listed below.

• Your stock in trade.
• Property that would properly be included in your inventory if on hand at the close of the tax year.
• Property held by you primarily for sale to customers in the ordinary course of your trade or business.

Tax-exempt bonds. If the bond yields tax-exempt interest, you must amortize the premium. You cannot deduct the amortizable premium in figuring your taxable income. However, each year you must reduce your basis in the bond by the amortization for the year.

Taxable bonds. You can choose to amortize the premium on taxable bonds. This generally means that each year, over the life of the bond, you use part of the premium to reduce the amount of interest includible in your income. If you make this choice, you must reduce your basis in the bond by the amortization for the year. The premium on the bond is part of your basis in the bond.

Inflation-indexed instruments. An inflation-indexed debt instrument is generally a debt instrument on which the payments are adjusted for inflation and deflation (such as Treasury inflation-indexed securities). Determine the premium on an inflation-indexed debt instrument as of the date you acquire the instrument by assuming that there will be no inflation or deflation over the remaining term of the instrument. Allocate the premium over the remaining term of the instrument by making the same assumption. Reduce the instrument's interest income for the tax year by the premium allocable to the tax year. Use any excess premium allocable to the tax year to offset the original issue discount on the instrument for the year.

Basis adjustment. If you are required to amortize bond premium, or choose to do so, you must decrease the basis of the bond by the amortizable bond premium. The result is the adjusted basis you use to figure gain or loss on the sale or redemption of the bond.

More information. For more information on how to figure and report bond premium, see Publication 550.

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