Treasury Regulations · 26 CFR
§ 1.1232-3. Gain upon sale or exchange of obligations issued at a discount after December 31, 1954.
Regulation text, no changes From the eCFR, current as of October 15, 2026. The eCFR is an authoritative but unofficial editorial compilation of the Code of Federal Regulations; the official text is the annual CFR on govinfo. Compare it with this section on ecfr.gov (external site) or the official annual CFR on govinfo (external site).
Cite as 26 CFR § 1.1232-3
At a glance
Read from the text and its source citation. Not part of the regulation.
- Status
- In the current eCFR
- Issued
- November 26, 1960 by T.D. 6500
- Last amended
- November 3, 1980 by T.D. 7728
- Length
- 9,739 words · about 42 min to read
- Defines
- 12 terms
- Cross-references
- cites 18 Code sections and 9 regulations; cited by 11
(a) If at the time of original issue there was no intention to call the obligation before maturity, such gain shall be considered as long-term capital gain, or
(b) If at the time of original issue there was an intention to call the obligation before maturity, such gain shall be considered ordinary income to the extent it does not exceed the excess of:
The balance, if any, of the gain shall be considered as long-term capital gain. The amount described in (2) of this subdivision (b) in effect reduces the amount of original issue discount to be treated as ordinary income under this subdivision (b) by the amounts previously includible (regardless of whether included) by all holders (computed, however, as to any holder without regard to any purchase allowance under paragraph (a)(2)(ii) of § 1.1232-3A and without regard to whether any holder purchased at a premium as defined in paragraph (d)(2) of § 1.1232-3).
On January 1, 1970, A, a calendar-year taxpayer, purchases at original issue for cash of $7,600, M Corporation's 10-year, 5 percent bond which has a stated redemption price at maturity of $10,000. On January 1, 1972, A sells the bond to B, for $9,040. A has previously included $480 of the original issue discount in his gross income (see example (1) of paragraph (d) of § 1.1232-3A) and increased his basis in the bond by that amount to $8,080 (see paragraph (c) of § 1.1232-3A). Thus, if at the time of original issue there was no intention to call the bond before maturity, A's gain of $960 (amount realized, $9,040, less adjusted basis, $8,080) is considered long-term capital gain.
(i) Assume the same facts as in example (1), except that at the time of original issue there was an intention to call the bond before maturity. The amount of the entire gain includible by A as ordinary income under subparagraph (1)(i) of this paragraph is determined as follows:
| (1) Entire original issue discount (stated redemption price at maturity, $10,000, minus issue price, $7,600) | $2,400 |
| (2) Less: Line (1), $2,400, multiplied by months elapsed since date of original issue, 24, divided by months from such date to stated maturity date, 120 | $480 |
| (3) Maximum amount includible by A as ordinary income | $1,920 |
Since the amount in line (3) is greater than A's gain, $960, A's entire gain is includible as ordinary income.
(ii) On January 1, 1979, B, a calendar-year taxpayer, sells the bond to C for $10,150. Assume that B has included $120 of original issue discount in his gross income for each taxable year he held the bond (see example (2) of paragraph (d) of § 1.1232-3A) and therefore increased his basis by $840 (i.e., $120 each year × 7 years) to $9,880. B's gain is therefore $270 (amount realized, $10,150, less basis, $9,880). The amount of such gain includible by B as ordinary income under subparagraph (1)(i) of this paragraph is determined as follows:
| (1) Entire original issue discount (as determined in part (i) of this example) | $2,400 |
| (2) Less: Line (1), $2,400, multiplied by months elapsed since date of original issue, 108, divided by months from such date to stated maturity date, 120 | $2,160 |
| (3) Maximum amount includible by B as ordinary income | $240 |
Since the amount in line (3) is less than B's gain, $270, only $240 of B's gain is includible as ordinary income. The remaining portion of B's gain, $30, is considered long-term capital gain.
And the balance, if any, of the gain shall be considered as long-term capital gain. For the definition of the terms original issue discount and intention to call before maturity, see paragraphs (b) (1) and (4) respectively of this section. See section 1037(b) and paragraph (b) of § 1.1037-1 for special rules which are applicable in applying section 1232(a)(2)(B) and this subparagraph to gain realized on the disposition or redemption of obligations of the United States which were received from the United States in an exchange upon which gain or loss is not recognized because of section 1037(a) (or so much of section 1031 (b) or (c) as relates to section 1037(a)).
(b) Special rules. In the case of face -amount certificates, the redemption price at maturity is the price as modified through changes such as extensions of the purchase agreement and includes any dividends which are payable at maturity. In the case of an obligation issued as part of an investment unit consisting of such obligation and an option (which is not excluded by (c) of this subdivision (iii)), security, or other property, the term stated redemption price at maturity means the amount payable on maturity in respect of the obligation, and does not include any amount payable in respect of the option, security, or other property under a repurchase agreement or option to buy or sell the option, security, or other property. For application of this subdivision to certain deposits in financial institutions, see paragraph (e) of § 1.1232-3A.
(c) Excluded option. An option is excluded by this subdivision (c) if it is an option to which paragraph (a) of § 1.61-15 applies or if it is an option, referred to in paragraph (a) of § 1.83-7, granted in connection with performance of services to which section 421 does not apply.
(d) Obligation issued in installments. If an obligation is issued by a corporation under terms whereby the holder makes installment payments, then the stated redemption price for each installment payment shall be computed in a manner consistent with the rules contained in subparagraph (2)(iv) of this paragraph for computing the issue price for each series of a serial obligation. For application of this subdivision (d) to certain open account deposit arrangements, see examples (1) and (2) of paragraph (e)(5)(ii) of § 1.1232-3A.
(e) Application of definition. Subdivision (a)(2) of this paragraph (b)(1)(iii) shall not apply:
(b) Agreement as to assumed price. In the case of an investment unit which is privately placed, the assumed price at which the obligation would have been issued had it been issued apart from such unit may be agreed to by the issuer and the original purchaser of the investment unit in writing on or before the date of purchase. Alternatively, an agreement between the issuer and original purchaser may specify the rate of interest which would have been paid on the obligation if the transaction were one not involving the issuance of options, and an assumed issue price may be determined (in the manner described in (a) of this subdivision) from such agreed assumed rate of interest. An assumed price based upon such an agreement between the parties will generally be presumed to be the issue price of the obligation with respect to the issuer, original purchaser, and all subsequent holders: Provided, That the agreement was made in arm's length negotiations between parties having adverse interests: And, provided further, That such price does not, under the rules stated in (a) of this subdivision, appear to be clearly erroneous. An assumed issue price agreed to by the parties as provided herein will not be considered clearly erroneous if it is not less than the face value adjusted (in the manner described in (a) of this subdivision) to a yield which is one percentage point greater than the actual rate of interest payable on the obligation. Similarly, if the agreement between the parties specifies an agreed assumed rate of interest (in lieu of an agreed assumed issue price) and such agreed rate is not more than 1 percentage point greater than the actual rate payable on the obligation, an adjusted issue price based upon such agreed assumed rate of interest will not be considered clearly erroneous.
(c) Cross references. For rules relating to the deductibility by the issuing corporation of bond discount resulting from an allocation under the rule stated in (a) of this subdivision, see §§ 1.163-3 and 1.163-4. For rules relating to the basis of obligations and options, securities, or other property acquired in investment units, see § 1.1012-1(d). For rules relating to certain reporting requirements with respect to options acquired in connection with evidences of indebtedness and for the tax treatment of such options, see § 1.61-15, and section 1234 and the regulations thereunder. With respect to the tax consequences to the issuing corporation upon the exercise of options issued in connection with evidences of indebtedness to which this section applies, see section 1032 and the regulations thereunder.
(d) Examples. The application of the principles set forth in this subdivision (ii) may be illustrated by the following examples in each of which it is assumed that there was no intention to call the note before maturity:
M Corporation is a small manufacturer of electronic components located in the southwestern United States. On January 1, 1969, in consideration for the payment of $41,500, M issues to X its unsecured note for $40,000 together with warrants to purchase 3,000 shares of M stock at $10 per share at any time during the term of the note. The note is payable in 4 years and provides for interest at the rate of 5 percent per year, payable semiannually. The fair market values of the note and the warrants are not readily ascertainable. Assume that companies in the same industry as M Corporation, and similarly situated both financially and geographically, are generally able to borrow money on their unsecured notes at an annual interest rate of 6 percent. Using a present value table, the calculation of the issue price of a 5 percent, 4 year, $40,000 note, discounted to yield 6 percent compounded semiannually is made as follows:
| (1) | (2) | (3) | (2) × (3) |
|---|---|---|---|
| Semiannual interest period | Amount payable at 5 percent | Factor for present value discounted at 3 percent per period | Present value of payment |
| 1 | $1,000 | 0.9709 | $970.90 |
| 2 | 1,000 | .9426 | 942.60 |
| 3 | 1,000 | .9151 | 915.10 |
| 4 | 1,000 | .8885 | 888.50 |
| 5 | 1,000 | .8626 | 862.60 |
| 6 | 1,000 | .8375 | 837.50 |
| 7 | 1,000 | .8131 | 813.10 |
| 8 | 1,000 | .7894 | 789.40 |
| 8 | 40,000 | .7804 | 31,576.00 |
| Total present value of note discounted at 6 percent, compounded semiannually | 38,595.70 | ||
The same result may be reached through the use of a standard bond table or by the following present value calculation:
| Present value of annuity of $1,000 payable over 8 periods at 3 percent per period = 1000 × 7.0197 = | $7,019.70 |
| Add: Present value of principal (as calculated above) | 31,576.00 |
| Total | $38,595.70 |
Accordingly, the assumed price at which M's note would have been issued had it been issued without stock purchase warrants, i.e., that portion of the $41,500 price paid by X which is allocable to M's note, is $38,596 (rounded). Since the price payable on redemption of M's note at maturity is $40,000, the original issue discount on M's note is $1,404 ($40,000 minus $38,596). Under the rules stated in § 1.163-3, M is entitled to a deduction, to be prorated or amortized over the life of the note, equal to this original issue discount on the note. The excess of the price for the unit over the portion of such price allocable to the note, $2,904 ($41,500 minus $38,596), is allocable to and is the basis of the stock purchase warrants acquired by X in connection with M's note. Upon the exercise of X's warrants, M will be allowed no deduction and will have no income. Upon maturity of the note X will receive $40,000 from M, of which $1,404, the amount of the original issue discount, will be taxable as ordinary income. If X were to transfer the note at its face amount to A 2 years after the issue date, X would realize, under section 1232(a)(2)(B), ordinary income of $702 (one-half of $1,404).
(1) On January 1, 1969, N Corporation negotiates with Y, a small business investment company, for a loan in the amount of $51,500 in consideration of which N Corporation issues to Y its unsecured 5-year note for $50,000, together with warrants to purchase 2,000 shares of N stock at $5 per share at any time during the term of the note. The note provides for interest of 6 percent, payable semiannually. The fair market values of the note and warrants are not readily ascertainable. The loan agreement between Y and N contains a provision, agreed to in arms-length bargaining between the parties, that a rate of 7 percent payable semiannually would have been applied to the loan if warrants were not issued as part of the consideration for the loan. The issue price of the note is $47,921 (rounded), determined with the use of a standard bond table, or computed in the manner illustrated in Example 1 or in the following alternative manner:
| (1) | (2) | (3) | (4) | (5) | (4) × (5) |
|---|---|---|---|---|---|
| Interest period | Interest rate differential | Principal | Interest foregone for period (1⁄2%) | Factor for present value discounted at 31⁄2 percent per period | Present value of interest foregone |
| 1 | 1%(7%-6%) | $50,000 | 250 | 0.9662 | $241.53 |
| 2 | 1% | 50,000 | 250 | .9335 | 233.38 |
| 3 | 1% | 50,000 | 250 | .9019 | 225.48 |
| 4 | 1% | 50,000 | 250 | .8714 | 217.85 |
| 5 | 1% | 50,000 | 250 | .8420 | 210.50 |
| 6 | 1% | 50,000 | 250 | .8135 | 203.38 |
| 7 | 1% | 50,000 | 250 | .7860 | 196.50 |
| 8 | 1% | 50,000 | 250 | .7594 | 189.85 |
| 9 | 1% | 50,000 | 250 | .7337 | 183.43 |
| 10 | 1% | 50,000 | 250 | .7089 | 177.25 |
| Total present value of interest foregone | $2,079.15 | ||||
| Principal | 50,000.00 | ||||
| Less: Total present value of interest foregone | 2,079.15 | ||||
| Issue price | 47,920.85 | ||||
The calculation of present value of interest foregone may also be made as follows:
Present value of annuity of $250 discounted for 10 periods at 3 1/2 percent per period = $250 × 8.3166 = $2,079.15.
The total present value of interest foregone, $2,079, is also the original issue discount attributable to the note ($50,000 −$47,921). Under (b) of this subdivision, since the agreed assumed rate of interest of 7 percent is not more than 1 percentage point greater than the actual rate payable on the note, determination of the issue price of the note (and original issue discount) based upon such assumed rate will be presumed to be correct and will not be considered clearly erroneous, provided that both N and Y adhere to such determination. Under the rules in § 1.163-3, N is entitled to a deduction, to be prorated or amortized over the life of the note, equal to the original issue discount on the note. The excess of the price paid for the unit over the portion of such price allocable to the note, $3,579 ($51,500−$47,921) is allocable to and is the basis of the stock purchase warrants acquired by Y in connection with N's note. Upon the exercise or sale of the warrants by Y, N will be allowed no deduction and will have no income. Upon maturity of the note Y will receive $50,000 from N, of which $2,079, the amount of the original issue discount, will be taxable as ordinary income. If Y were to transfer the note at its face value to B 2 1/2 years after the issue date, Y would realize, under section 1232(a)(2)(B), ordinary income of $1,039.50 (one-half of $2,079).
(2) Assume that instead of the parties agreeing on an assumed interest rate at which the obligation would have been issued without the warrants, the parties agreed that the obligation at the actual 6 percent rate would have been issued without the warrants at a discounted price of $48,000. In this situation the agreed assumed issue price is presumed to be correct since it is not less than the face value adjusted (in the manner illustrated in part (1) of this example) to a yield which is one percentage point greater than the actual rate of interest payable on the obligation ($47,921).
O Corporation is a small advertising company located in the northeastern United States. Z is a tax-exempt organization. In consideration for the payment of $60,000, O issues to Z, in a transaction not within the scope of section 503(b), its unsecured 5-year note for $60,000, together with warrants to purchase 6,000 shares of O stock at $10 per share at any time during the term of the note. The note is subject to quarterly amortization at the rate of $3,000 per quarter, and provides for interest on the outstanding unpaid balance at an annual rate of 6 percent payable quarterly (1 1/2 percent per quarter). The fair market values of the notes and warrants are not readily ascertainable. The loan agreement between O and Z contains a recital that if the $60,000 note had been issued without the warrants only $45,000 would have been paid for it. An examination of relevant facts indicates that companies in the same industry as O Corporation, and similarly situated both financially and geographically, are able to borrow money on their unsecured notes at an annual interest cost of 8 1/2 percent payable quarterly (2 1/8 percent per quarter). By reference to a present value table, it is found that the present value of O's note discounted to yield 8 1/2 percent compounded quarterly is $56,608 (rounded). The computation is as follows:
| (1) | (2) | (3) | (4) | (5) | (6) |
|---|---|---|---|---|---|
| Quarterly interest period | Principal payable | Interest payable (11⁄2 percent) | Total amount payable (2) + (3) | Factor for present value discounted at 21⁄8 percent per quarter | Present value of total payment (4) × (5) |
| 1 | $3,000 | $900 | $3,900 | 0.9792 | $3,818.88 |
| 2 | 3,000 | 855 | 3,855 | .9588 | 3,696.17 |
| 3 | 3,000 | 810 | 3,810 | .9389 | 3,577.21 |
| 4 | 3,000 | 765 | 3,765 | .9193 | 3,461.16 |
| 5 | 3,000 | 720 | 3,720 | .9002 | 3,348.74 |
| 6 | 3,000 | 675 | 3,675 | .8815 | 3,239.51 |
| 7 | 3,000 | 630 | 3,630 | .8631 | 3,133.05 |
| 8 | 3,000 | 585 | 3,585 | .8452 | 3,030.04 |
| 9 | 3,000 | 540 | 3,540 | .8276 | 2,929.70 |
| 10 | 3,000 | 495 | 3,495 | .8104 | 2,832.35 |
| 11 | 3,000 | 450 | 3,450 | .7935 | 2,737.58 |
| 12 | 3,000 | 405 | 3,405 | .7770 | 2,645.69 |
| 13 | 3,000 | 360 | 3,360 | .7608 | 2,556.29 |
| 14 | 3,000 | 315 | 3,315 | .7450 | 2,469.68 |
| 15 | 3,000 | 270 | 3,270 | .7295 | 2,385.47 |
| 16 | 3,000 | 225 | 3,225 | .7143 | 2,303.62 |
| 17 | 3,000 | 180 | 3,180 | .6994 | 2,224.09 |
| 18 | 3,000 | 135 | 3,135 | .6849 | 2,147.16 |
| 19 | 3,000 | 90 | 3,090 | .6706 | 2,072.15 |
| 20 | 3,000 | 45 | 3,045 | .6567 | 1,999.65 |
| Total | 56,608.19 | ||||
This amount ($56,608) is the assumed price at which the note would have been issued had it been issued without stock purchase warrants. The assumed price of $45,000 agreed to by the parties is not presumed to be correct since it is less than the face value adjusted to a yield which is one percentage point greater than the actual rate of interest payable on the obligation. The parties did not have adverse interests in agreeing upon an assumed price (since an excessively large amount of original issue discount would benefit O, the borrower, without adversely affecting Z, an exempt organization which would pay no tax on original issue discount income), and the price agreed to appears to be clearly erroneous when compared to the $56,608 assumed issue price determined under the principles of (a) of this subdivision. Since the maturity value of O's note is $60,000, the original issue discount on O's note is $3,392 ($60,000 minus $56,608). Under the rules in § 1.163-3, O is entitled to a deduction, to be prorated or amortized over the life of the note, equal to this original issue discount on the note. The excess of the price paid for the unit over the portion of such price allocable to the note, $3,392 ($60,000 minus $56,608), is allocable to and is the basis of the stock purchase warrants acquired by Z in connection with O's note. Upon the exercise or sale of the warrants by Z, O will be allowed no deduction and will have no income.
(b) Exceptions for original issue discount. If an obligation or investment unit is issued for property in an exchange which is not pursuant to a plan of reorganization referred to in (d) of this subdivision, and if:
then the issue price of the obligation or investment unit shall be the fair market value of the property for which such obligation or investment unit is issued, as determined under (c) of this subdivision. Such issue price shall control for purposes of determining the amount realized by the person exchanging the property for the obligation or unit issued and the bases of the property acquired by the holder and issuer.
An obligation which is not traded on an established securities market and which is not part of an issue or investment unit a portion of which is so traded shall not be treated as property described in (1) of this (b) even though the obligation is convertible into property so traded. For purposes of this (b), an obligation, investment unit, or element of an investment unit shall be treated as traded on an established securities market if it is so traded on or within 10 trading days after the date it is issued. Trading days shall mean those days on which an established securities market is open. For purposes of this subdivision (iii), the term established securities market shall have the same meaning as in paragraph (d)(4) of § 1.453-3 (relating to limitations on installment method for purchaser evidences of indebtedness payable on demand or readily tradable).
(c) Determination of fair market value in cases to which (b) of this subdivision applies. In general, for purposes of (b) of this subdivision, the fair market value of property for which an obligation or investment unit is issued shall be deemed to be the same as the fair market value of such obligation or investment unit, determined by reference to the fair market value of that portion of the issue, of which such obligation or unit is a part, which is traded on an established securities market. The fair market value of such obligation or unit shall be determined as of the first date after the date of issue (within the meaning of section 1232(b)(3)) that such obligation or unit is traded on an established securities market. If, however, the obligation or investment unit is not part of an issue a portion of which is traded on an established securities market, but the property for which the obligation or investment unit is issued is stock or securities which are traded on an established securities market, the fair market value of such property shall be the fair market value of such stock or securities on the date such obligation or unit is issued for such property. The fair market value of property for purposes of this (c) shall be determined as provided in § 20.2031-2 of this chapter (Estate Tax Regulations) but without applying the blockage and other special rules contained in paragraph (e) thereof.
(d) Not in reorganization. An exchange which is not pursuant to a reorganization referred to in this subdivision (d) is an exchange in which the obligation or investment unit is not issued pursuant to a plan of reorganization within the meaning of section 368(a)(1) or pursuant to an insolvency reorganization within the meaning of section 371, 373, or 374. Thus, for example, no original issue discount is created on an obligation issued in a recapitalization within the meaning of section 368(a)(1)(E). Similarly, no original issue discount is created on an obligation issued in an exchange, pursuant to a plan of reorganization, to which section 361 applies regardless of the income tax consequences to any person who pursuant to such plan is the ultimate recipient of the obligation. The application of section 351 shall not preclude the creation of original issue discount. For carryover of original issue discount in the case of an exchange of obligations pursuant to a plan of reorganization, see subparagraph (1)(iv) of this paragraph.
(e) Effective date. Determinations with respect to obligations issued on or before May 27, 1969, or pursuant to a written commitment which was binding on that date and at all times thereafter, shall be made without regard to this subdivision (iii).
(b) Issue price not independently established. If a separate issue price cannot be established with respect to each series of an issue of obligations which matures serially, the issue price for each obligation of each series shall be its stated redemption price at maturity minus the amount of original issue discount allocated thereto in accordance with (d) of this subdivision. The amount of original issue discount so allocated shall be ratably included as interest in gross income under rules of § 1.1232-3A.
(c) Single obligation rule. If a single corporate obligation provides for payments (other than payments which would not be included in the stated redemption price at maturity under subparagraph (1)(iii) of this paragraph) in two or more installments, the provisions of (b) of this subdivision shall be applied by treating such obligation as an issue of obligations consisting of more than one series each of which matures on the due date of each such installment payment.
(d) Allocation of discount. For purposes of (b) and (c) of this subdivision, the original issue discount with respect to each series of an issue shall be the total original issue discount for the issue multiplied by a fraction:
If a series consists of more than one obligation, the original issue discount allocated to such series shall be apportioned to such obligations in proportion to the stated redemption price of each. Computations under this subdivision (d) may be made using periods other than years, such as, for example, months or periods of 3 months.
(e) Effective date. The provisions of this subdivision (iv) shall apply with respect to corporate obligations issued after July 22, 1971. However, no inference shall be drawn from the preceding sentence with respect to serial obligations issued prior to such date.
(f) Examples. The provisions of this subdivision (iv) may be illustrated by the following examples:
On January 1, 1972, P Corporation issued a note with a total face value of $100,000 to B for cash of $94,000. The terms of the note provide that $50,000 is payable on December 31, 1973, and the other $50,000 on December 31, 1975. Each payment is treated as the stated redemption price of a series, and the total original issue discount with respect to the note, $6,000, is allocated to each such series as follows:
| Year of maturity | 1973 | 1975 | Total |
|---|---|---|---|
| (1) Stated redemption price | $50,000 | $50,000 | |
| (2) Multiply by years outstanding | 2 | 4 | |
| (3) Product of bond years | $100,000 | $200,000 | |
| (4) Sum of products | $300,000 | ||
| (5) Fractional portion of discount | $100,000 | $200,000 | |
| $300,000 | $300,000 | ||
| (6) Multiply line (5) by discount for entire issue | $6,000 | $6,000 | |
| (7) Discount for each series | $2,000 | $4,000 | |
| (8) Issue price (line (1), minus line (7)) | $48,000 | $46,000 |
Assume the same facts as in example (1) except that a separate note is issued for each payment. The result is the same as in example (1).
On January 1, 1971, Y Bank, a corporation, issues a note to C for $1,000 cash. The terms of the note provide that $50 will be paid at the end of the first year, $120 at the end of the second year, and $1,050 at the end of the third year. Under (c) of this subdivision (iv), the $1,000 note is treated as consisting of two series, the first of which matures at the end of the second year, and the second of which matures at the end of the third year. The issue price and the allocation of original issue discount with respect to each series is computed as follows:
| Year of maturity | 1972 | 1973 | Total |
|---|---|---|---|
| (1) Stated redemption price | $70 | $1,000 | |
| (2) Multiply by years outstanding | 2 | 3 | |
| (3) Product of bond years | $140 | $3,000 | |
| (4) Sum of products | $3,140 | ||
| (5) Fractional portion of discount | $140 | $3,000 | |
| $3,140 | $3,140 | ||
| (6) Multiply line (5) by discount for entire issue | $70 | $70 | |
| (7) Discount for each series | $3.12 | $66.88 | |
| (8) Issue price (line 1 minus line (7)) | $66.88 | $933.12 |
(b) Circumstances indicating absence of understanding. Examples of circumstances which would be evidence that there was no understanding at the time of original issue to redeem the obligation before maturity are:
(c) Gain treated as ordinary income in certain cases; computation. The amount of gain treated as ordinary income under paragraph (a) (3)(ii) or (5) of this section is computed by multiplying the original issue discount by a fraction, the numerator of which is the number of full months the obligation was held by the holder and the denominator of which is the number of full months from the date of original issue to the date specified as the redemption date at maturity. (See paragraph (b)(3) of this section for definition of date of original issue.) The period that the obligation was held by the taxpayer shall include any period that it was held by another person if, under chapter 1 of the Code, for the purpose of determining gain or loss from a sale or exchange, the obligation has the same basis, in whole or in part, in the hands of the taxpayer as it would have in the hands of such other person. This computation is illustrated by the following examples:
An individual purchases a 10-year, 3-percent coupon bond for $900 on original issue on February 1, 1955, and sells it on February 20, 1960, for $940. The redemption price is $1,000. At the time of original issue, there was no intention to call the bond before maturity. The bond has been held by the taxpayer for 60 full months. (The additional days amounting to less than a full month are not taken into account.) The number of complete months from date of issue to date of maturity is 120 (10 years). The fraction 60/120 multiplied by the discount of $100 is equal to $50, which represents the proportionate part of the original issue discount attributable to the period of ownership by the taxpayer. Accordingly, any part of the gain up to $50 will be treated as ordinary income. Therefore, in this case the entire gain of $40 is treated as ordinary income.
Assume the same facts in the preceding example, except that the selling price of the bond is $970. In this case $50 of the gain of $70 is treated as ordinary income and the balance of $20 is treated as long-term capital gain.
Assume the same facts as in example (1), except that the selling price of the bond is $800. In this case, the individual has a long-term capital loss of $100.
Assume the same facts as in example (1), except that the bond is purchased by the second holder February 1, 1960, for $800. The second holder keeps it to the maturity date (February 1, 1965) when it is redeemed for $1,000. Since that holder has held the bond for 60 full months, he will, upon redemption, have $50 in ordinary income and $150 in long-term capital gain.
(d) Exceptions to the general rule—(1) In general. Section 1232(a)(2)(C) provides that section 1232(a)(2) does not apply (i) to obligations the interest on which is excluded from gross income under section 103 (relating to certain government obligations), or (ii) to any holder who purchases an obligation at a premium.
(e) Amounts previously includible in income. Nothing in section 1232(a)(2) shall require the inclusion of any amount previously includible in gross income. Thus, if an amount was previously includible in a taxpayer's income on account of obligations issued at a discount and redeemable for fixed amounts increasing at stated intervals, or, under section 818(b) (relating to accrual of discount on bonds and other evidences of indebtedness held by life insurance companies), such amount is not again includible in the taxpayer's gross income under section 1232(a)(2). For example, amounts includible in gross income by a cash receipts and disbursements method taxpayer who has made an election under section 454 (a) or (c) (relating to accounting rules for certain obligations issued at a discount to which section 1232(a)(3) does not apply) are not includible in gross income under section 1232(a)(2). In the case of a gain which would include, under section 1232(a)(2), an amount considered to be ordinary income and a further amount considered long-term capital gain, any amount to which this paragraph applies is first used to offset the amount considered ordinary income. For example, on January 1, 1955, A purchases a 10-year bond which is redeemable for fixed amounts increasing at stated intervals. At the time of original issue, there was no intention to call the bond before maturity. The purchase price of the bond is $75, which is also the issue price. The stated redemption price at maturity of the bond is $100. A elects to treat the annual increase in the redemption price of the bond as income pursuant to section 454(a). On January 1, 1960, A sells the bond for $90. The total stated increase in the redemption price of the bond which A has reported annually as income for the taxable years 1955 through 1959 is $7. The portion of the original issue discount of $25 attributable to this period is $12.50, computed as follows:
60 (months bond is held by A)/120 (months from date of original issue to redemption date) × $25 (original issue discount)
However, $7, which represents the annual stated increase taken into income, is offset against the amount of $12.50, leaving $5.50 of the gain from the sale to be treated as ordinary income.
(f) Recordkeeping requirements. In the case of any obligation held by a taxpayer which was issued at an original issue discount after December 31, 1954, the taxpayer shall keep a record of the issue price and issue date upon or with each obligation (if known to or reasonably ascertainable by him). If the obligation held by the taxpayer is an obligation of the United States received from the United States in an exchange upon which gain or loss is not recognized because of section 1037 (a) (or so much of section 1031 (b) or (c) as relates to section 1037(a)), the taxpayer shall keep sufficient records to determine the issue price of such obligation for purposes of applying section 1037(b) and paragraphs (a) and (b) of § 1.1037-1 upon the disposition or redemption of such obligation. The issuer (or in the case of obligations first sold to the public through an underwriter or wholesaler, the underwriter or wholesaler) shall mark the issue price and issue date upon every obligation which is issued at an original issue discount after September 26, 1957, but only if the period between the date of original issue (as defined in paragraph (b)(3) of this section) and the stated maturity date is more than 6 months.
[T.D. 6500, 25 FR 12008, Nov. 26, 1960, as amended by T.D. 6984, 33 FR 19176, Dec. 21, 1968; T.D. 7154, 36 FR 25000, Dec. 28, 1971; 37 FR 527, Jan. 13, 1972; T.D. 7213, 37 FR 21992, Oct. 18, 1972; 37 FR 22863, Oct. 26, 1972; T.D. 7663, 44 FR 76782, Dec. 28, 1979; T.D. 7728, 45 FR 72650, Nov. 3, 1980]
Terms defined here
Where the text says “the term … means”. Select a term to jump to its definition.
- date of original issue § 1.1232-3(b)(3)
- date of original issue § 1.1232-3(b)(3)
- established securities market § 1.1232-3(b)(2)(iii)(2)
- initial offering price § 1.1232-3(b)(2)(i)
- intention to call the bond or other evidence of indebtedness before maturity § 1.1232-3(b)(4)(i)
- original issue discount § 1.1232-3(a)(5)
- original issue discount § 1.1232-3(b)(1)(i)
- original purchaser § 1.1232-3(b)(4)(i)
- price paid by the first buyer § 1.1232-3(b)(2)(i)
- stated redemption price at maturity § 1.1232-3(b)(1)(iii)
- stated redemption price at maturity § 1.1232-3(b)(1)(iii)
- the public § 1.1232-3(b)(2)(i)
Cross-references
Computed from the citations in the text of 26 CFR.
Code sections it cites
- § 582 Bad debts, losses, and gains with respect to securities held by financial institutions
- § 1037 Certain exchanges of United States obligations
- § 1031 Exchange of real property held for productive use or investment
- § 451 General rule for taxable year of inclusion
- § 421 General rules
- § 871 Tax on nonresident alien individuals
- § 354 Exchanges of stock and securities in certain reorganizations
- § 4911 Tax on excess expenditures to influence legislation
- § 1234 Options to buy or sell
- § 1032 Exchange of stock for property
- § 503 Requirements for exemption
- § 368 Definitions relating to corporate reorganizations
- § 361 Nonrecognition of gain or loss to corporations; treatment of distributions
- § 351 Transfer to corporation controlled by transferor
- § 267 Losses, expenses, and interest with respect to transactions between related taxpayers
- § 103 Interest on State and local bonds
- § 818 Other definitions and special rules
- § 454 Obligations issued at discount
Regulations it cites
- § 1.1232-3A Inclusion as interest of original issue discount on certain obligations issued after May 27, 1969.
- § 1.1037-1 Certain exchanges of United States obligations.
- § 1.61-15 Options received as payment of income.
- § 1.83-7 Taxation of nonqualified stock options.
- § 1.163-4 Deduction for original issue discount on certain obligations issued after May 27, 1969.
- § 1.163-3 Deduction for discount on bond issued on or before May 27, 1969.
- § 1.1012-1 Basis of property.
- § 1.453-3 Purchaser evidences of indebtedness payable on demand or readily tradable.
- § 20.2031-2 Valuation of stocks and bonds.
Cited by 11 other regulations
- § 1.61-15 Options received as payment of income.
- § 1.163-3 Deduction for discount on bond issued on or before May 27, 1969.
- § 1.163-4 Deduction for original issue discount on certain obligations issued after May 27, 1969.
- § 1.993-2 Definition of qualified export assets.
- § 1.1012-1 Basis of property.
- § 1.1232-1 Bonds and other evidences of indebtedness; scope of section.
- § 1.1232-3A Inclusion as interest of original issue discount on certain obligations issued after May 27, 1969.
- § 1.6049-1 Returns of information as to interest paid in calendar years before 1983 and original issue discount includible in gross income for calendar years before 1983.
- § 1.6049-2 Interest and original issue discount subject to reporting in calendar years before 1983.
- § 1.6049-4 Return of information as to interest paid and original issue discount includible in gross income after December 31, 1982.
- § 1.6049-5 Interest and original issue discount subject to reporting after December 31, 1982.
Amendment history
From the source citation at the end of the section, newest first. T.D. is a Treasury decision; FR is the Federal Register.
- Amended by T.D. 7728 (45 FR 72650)
- Amended by T.D. 7663 (44 FR 76782)
- Amended (37 FR 22863)
- Amended by T.D. 7213 (37 FR 21992)
- Amended (37 FR 527)
- Amended by T.D. 7154 (36 FR 25000)
- Amended by T.D. 6984 (33 FR 19176)
- Issued by T.D. 6500 (25 FR 12008)
Where it sits in 26 CFR
- Subchapter A Income tax
- Part 1 Income taxes
- Special Rules for Determining Capital Gains and Losses
Nearby sections
- § 1.1231-1 Gains and losses from the sale or exchange of certain property used in the trade or business.
- § 1.1231-2 Livestock held for draft, breeding, dairy, or sporting purposes.
- § 1.1232-1 Bonds and other evidences of indebtedness; scope of section.
- § 1.1232-3 Gain upon sale or exchange of obligations issued at a discount after December 31, 1954.
- § 1.1232-3A Inclusion as interest of original issue discount on certain obligations issued after May 27, 1969.
- § 1.1233-1 Gains and losses from short sales.
- § 1.1233-2 Hedging transactions.
- § 1.1234-1 Options to buy or sell.