26 CFR § 1.1232-3 - Gain upon sale or exchange of obligations issued at a discount after December 31, 1954.
(a) General rule; sale or exchange—(1) Obligations issued by a corporation after May 27, 1969—(i) General rule. Under section 1232(a)(2)(A), in the case of gain realized upon the sale or exchange of an obligation issued at a discount by a corporation after May 27, 1969 (other than an obligation subject to the transitional rule of subparagraph (4) of this paragraph), and held by the taxpayer for more than 1 year (6 months for taxable years beginning before 1977; 9 months for taxable years beginning in 1977):
(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:
(1) An amount equal to the entire original issue discount, over
(2) An amount equal to the entire original issue discount multiplied by a fraction the numerator of which is the sum of the number of complete months and any fractional part of a month elapsed since the date of original issue and the denominator of which is the number of complete months and any fractional part of a month from the date of original issue to the stated maturity date.
(ii) Cross references. For definition of the terms original issue discount and intention to call before maturity, see paragraphs (b) (1) and (4) respectively of this section. For definition of the term date of original issue, see paragraph (b)(3) of this section. For computation of the number of complete months and any fractional portion of a month, see paragraph (a)(3) of § 1.1232-3A.
(iii) Effect of section 582(c). Gain shall not be considered to be long-term capital gain under subdivision (i) of this subparagraph if section 582(c) (relating to treatment of losses and gains on bonds of certain financial institutions) applies.
(2) Examples. The provisions of subparagraph (1) of this paragraph may be illustrated by the following examples:
| (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 |
| (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 |
(3) Obligations issued by a corporation on or before May 27, 1969, and government obligations. Under section 1232(a)(2)(B), if gain is realized on the sale or exchange after December 31, 1957, of an obligation held by the taxpayer more than 6 months, and if the obligation either was issued at a discount after December 31, 1954, and on or before May 27, 1969, by a corporation or was issued at a discount after December 31, 1954, by or on behalf of the United States or a foreign country, or a political subdivision of either, then such gain shall be considered ordinary income to the extent it does not exceed:
(i) An amount equal to the entire original issue discount, or
(ii) If at the time of original issue there was no intention to call the obligation before maturity, a portion of the original issue discount determined in accordance with paragraph (c) of this section,
(4) Transitional rule. Subparagraph (3) of this paragraph (in lieu of subparagraph (1) of this paragraph) shall apply to an obligation issued by a corporation pursuant to a written commitment which was binding on May 27, 1969, and at all times thereafter.
(5) Obligations issued after December 31, 1954, and sold or exchanged before January 1, 1958. Gain realized upon the sale or exchange before January 1, 1958, of an obligation issued at a discount after December 31, 1954, and held by the taxpayer for more than 6 months, shall be considered ordinary income to the extent it equals a specified portion of the original issue discount, and the balance, if any, of the gain shall be considered as long-term capital gain. The term original issue discount is defined in paragraph (b)(1) of this section. The computation of the amount of gain which constitutes ordinary income is illustrated in paragraph (c) of this section.
(6) Obligations issued before January 1, 1955. Whether gain representing original issue discount realized upon the sale or exchange of obligations issued at a discount before January 1, 1955, is capital gain or ordinary income shall be determined without reference to section 1232.
(b) Definitions—(1) Original issue discount—(i) In general. For purposes of section 1232, the term original issue discount means the difference between the issue price and the stated redemption price at maturity. The stated redemption price is determined without regard to optional call dates.
(ii) De minimis rule. If the original issue discount is less than one-fourth of 1 percent of the stated redemption price at maturity multiplied by the number of full years from the date of original issue to maturity, then the discount shall be considered to be zero. For example, a 10-year bond with a stated redemption price at maturity of $100 issued at $98 would be regarded as having an original issue discount of zero. Thus, any gain realized by the holder would be a long-term capital gain if the bond was a capital asset in the hands of the holder and held by him for more than 1 year (6 months for taxable years beginning before 1977; 9 months for taxable years beginning in 1977). However, if the bond were issued at $97.50 or less, the original issue discount would not be considered zero.
(iii) Stated redemption price at maturity—(a) Definition. Except as otherwise provided in this subdivision (iii), the term stated redemption price at maturity means the amount fixed by the last modification of the purchase agreement, including dividends, interest, and any other amounts, however designated, payable at that time. If any amount based on a fixed rate of simple or compound interest is actually payable or will be treated as constructively received under section 451 and the regulations thereunder either: (1) At fixed periodic intervals of one year or less during the entire term of an obligation, or (2) except as provided in subdivision (e) of this paragraph (b)(1)(iii), at maturity in the case of an obligation with a term of one year or less, any such amount payable at maturity shall not be included in determining the stated redemption price at maturity. For purposes of subdivision (a)(2) of this paragraph (b)(1)(iii), the term of an obligation shall include any renewal period with respect to which, under the terms of the obligation, the holder may either take action or refrain from taking action which would prevent the actual or constructive receipt of any interest on such obligation until the expiration of any such renewal period. To illustrate this paragraph (b)(1)(iii), assume that a note which promises to pay $1,000 at the end of three years provides for additional amounts labeled as interest to be paid at the rate of $50 at the end of the first year, $50 at the end of the second year, and $120 at the end of the third year. The stated redemption price at maturity will be $1,070 since only $50 of the $120 payable at the end of the third year is based on a fixed rate of simple or compound interest. If, however, the $120 were payable at the end of the second year, so that only $50 in addition to principal would be payable at the end of the third year, then under the rule for serial obligations contained in subparagraph (2)(iv)(c) of this paragraph, the $1,000 note is treated as consisting of two series. The first series is treated as maturing at the end of the second year at a stated redemption price of $70. The second series is treated as maturing at the end of the third year at a stated redemption price of $1,000. For the calculation of issue price and the allocation of original issue discount with respect to each such series, see example (3) of subparagraph (2)(iv)(f) of this paragraph.
(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:
(1) For taxable years beginning before September 19, 1979, if for the issuer's last taxable year beginning before September 19, 1978, the rules of § 1.163-4 were properly applied by the issuer, or
(2) In the case of an obligation with a term of six months or less held by a nonresident alien individual or foreign corporation, but only for purposes of the appliction of sections 871 and 881.
(iv) Carryover of original issue discount. If in pursuance of a plan of reorganization an obligation is received in an exchange for another obligation, and if gain or loss is not recognized in whole or in part on such exchange of obligations by reason, for example, of section 354 or 356, then the obligation received shall be considered to have the same original issue discount as the obligation surrendered reduced by the amount of gain (if any) recognized as ordinary income upon such exchange of obligations, and by the amount of original issue discount with respect to the obligation surrendered which was included as interest income under the ratable inclusion rules of sections 1232(a)(3) and 1.1232-3A. If inclusion as interest of the ratable monthly portion of original issue discount is required under section 1232(a)(3) with respect to the obligation received, see paragraph (a)(2)(iii) of § 1.1232-3A for computation of the ratable monthly portion of original issue discount. For special rules in connection with certain exchanges of U.S. obligations, see section 1037.
(2) Issue price defined—(i) In general. The term issue price in the case of obligations registered with the Securities and Exchange Commission means the initial offering price to the public at which price a substantial amount of such obligations were sold. For this purpose, the term the public does not include bond houses and brokers, or similar persons or organizations acting in the capacity of underwriters or wholesalers. Ordinarily, the issue price will be the first price at which the obligations were sold to the public, and the issue price will not change if, due to market developments, part of the issue must be sold at a different price. When obligations are privately placed, the issue price of each obligation is the price paid by the first buyer of the particular obligation, irrespective of the issue price of the remainder of the issue. In the case of an obligation issued by a foreign obligor, the issue price shall be increased by the amount, if any, of interest equalization tax paid under section 4911 (and not credited, refunded, or reimbursed) on the acquisition of the obligation by the first buyer. In the case of an obligation which is convertible into stock or another obligation, the issue price includes any amount paid in respect of the conversion privilege. However, in the case of an obligation issued as part of an investment unit (as defined in subdivision (ii)(a) of this subparagraph), the issue price of the obligation includes only that portion of the initial offering price or price paid by the first buyer properly allocable to the obligation under the rules prescribed in subdivision (ii) of this subparagraph. The terms initial offering price and price paid by the first buyer include the aggregate payments made by the purchaser under the purchase agreement, including modifications thereof. Thus, all amounts paid by the purchaser under the purchase agreement or a modification of it are included in the issue price (but in the case of an obligation issued as part of an investment unit, only to the extent allocable to such obligation under subdivision (ii) of this subparagraph), such as amounts paid upon face-amount certificates or installment trust certificates in which the purchaser contracts to make a series of payments which will be returnable to the holder with an increment at a later date.
(ii) Investment units consisting of obligations and property—(a) In general. An investment unit, within the meaning of this subdivision (ii) and for purposes of section 1232, consists of an obligation and an option, security, or other property. For purposes of this subparagraph, the initial offering price of an investment unit shall be allocated to the individual elements of the unit on the basis of their respective fair market values. However, if the fair market value of the option, security, or other property is not readily ascertainable (within the meaning of paragraph (c) of § 1.421-6), then the portion of the initial offering price or price paid by the first buyer of the unit which is allocable to the obligation issued as part of such unit shall be ascertained as of the time of acquisition of such unit by reference to the assumed price at which such obligation would have been issued had it been issued apart from such unit. The assumed price of the obligation shall be ascertained by comparison to the yields at which obligations of a similar character which are not issued as part of an investment unit are sold in arm's length transactions, and by adjusting the price of the obligation in question to this yield. The adjustment may be made by subtracting from the face amount of the obligation the total present value of the interest foregone by the purchaser as a result of purchasing the obligation at a lower yield as part of an investment unit. In most cases, assumed price may also be determined in a similar manner through the use of standard bond tables. Any reasonable method may be used in selecting an obligation for comparative purposes. Obligations of the same grade and classification shall be used to the extent possible, and proper regard shall be given, with respect to both the obligation in question and the comparative obligation, to the solvency of the issuer, the nature of the issuer's trade or business, the presence and nature of security for the obligation, the geographic area in which the loan is made, and all other factors relevant to the circumstances. An obligation which is convertible into stock or another obligation must not be used as a comparative obligation (except where the investment unit contains an obligation convertible into stock or another obligation), since such an obligation would not reflect the yield attributable solely to the obligation element of the investment unit.
(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:
| (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 | ||
| 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 |
| (1) | (2) | (3) | (4) | (5) | (4) × (5) |
|---|---|---|---|---|---|
| Interest period | Interest rate differential | Principal | Interest foregone for period (
|
Factor for present value discounted at 3
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 | ||||
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).
| (1) | (2) | (3) | (4) | (5) | (6) |
|---|---|---|---|---|---|
| Quarterly interest period | Principal payable | Interest payable (1
|
Total amount payable (2) + (3) | Factor for present value discounted at 2
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 | ||||
(iii) Issuance for property after May 27, 1969—(a) In general. Except as provided in (b) of this subdivision, if an obligation or an investment unit is issued for property other than money, the issue price of such obligation shall be the stated redemption price at maturity and, therefore, no original issue discount is created as a result of the exchange. However, in such case, there may be an amount treated as interest under section 483. In the case of certain exchanges of obligations of the United States for other such obligations, see section 1037 for the determination of the amount of original issue discount on the obligation acquired in the exchange. For carryover of original issue discount in the case of certain exchanges of obligations, see subparagraph (1)(iv) of this paragraph.
(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:
(1) The obligation, investment unit, or an element of the investment unit is part of an issue a portion of which is traded on an established securities market, or
(2) The property for which such obligation or investment unit is issued is stock or securities which are traded on an established securities market
(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).
(iv) Serial obligations—(a) In general. If an issue of obligations which matures serially is issued by a corporation, and if on the basis of the facts and circumstances in such case an independent issue price for each particular maturity can be established, then the obligations with each particular maturity shall be considered a separate series, and the obligations of each such series shall be treated as a separate issue with a separate issue price, maturity date, and stated redemption price at maturity. The ratable monthly portion of original issue discount attributable to each obligation within a particular series shall be determined and ratably included as interest in gross income under the rules of § 1.1232-3A.
(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:
(1) The numerator of which is the product of (i) the stated redemption price of such series and (ii) the number of complete years (and any fraction thereof) constituting the period for such series from the date of original issue (as defined in paragraph (b)(3) of this section) to its stated maturity date, and
(2) The denominator of which is the sum of the products determined in (1) of this subdivision (d) with respect to each such series.
(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:
| 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 |
| 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 |
(3) Date of original issue. In the case of issues of obligations which are registered with the Securities and Exchange Commission, the term date of original issue means the date on which the issue was first sold to the public at the issue price. In the case of issues which are privately placed, the term date of original issue means the date on which each obligation was sold to the original purchaser.
(4) Intention to call before maturity—(i) Meaning of term. For purposes of section 1232, the term intention to call the bond or other evidence of indebtedness before maturity means an understanding between (a) the issuing corporation (such corporation is hereinafter referred to as the issuer), and (b) the original purchaser of such obligation (or, in the case of obligations constituting part of an issue, any of the original purchasers of such obligations) that the issuer will redeem the obligation before maturity. For purposes of this subparagraph, the term original purchaser does not include persons or organizations acting in the capacity of underwriters or dealers, who purchased the obligation for resale in the ordinary course of their trade or business. It is not necessary that the issuer's intention to call the obligation before maturity be communicated directly to the original purchaser by the issuer. The understanding to call before maturity need not be unconditional; it may, for example, be dependent upon the financial condition of the issuer on the proposed early call date.
(ii) Proof of intent—(a) In general. Ordinarily, the existence or non-existance of an understanding at the time of original issue that the obligation will be redeemed before maturity shall be determined by an examination of all of the circumstances under which the obligation was issued and held. The fact that the obligation is issued with provisions on its face giving the issuer the privilege of redeeming the obligation before maturity is not determinative of an intention to call before maturity; likewise, the absence of such provision is not determinative of the absence of an intention to call before maturity. However, such provision, or the absence of such provision, is one of the circumstances to be given consideration along with other factors in determining whether an understanding existed. If the obligation was part of an issue registered with the Securities and Exchange Commission and was sold to the public (whether or not sold directly to the public by the obligor) without representation to the public that the obligor intends to call the obligation before maturity, there shall be a presumption that no intention to call the obligation before maturity was in existence at the time of original issue. The existence of a provision on the face of an obligation giving the issuer the privilege of redeeming the obligation before maturity shall not in and of itself overcome the presumption set forth in the preceding sentence.
(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:
(1) The issue price and term of the obligation appear to be reasonable, taking into account the interest rate, if any, on the obligation, for a corporation in the financial condition of the issuer at the time of issue.
(2) The original purchaser and the issuer are not related within the meaning of section 267(b) and have not engaged in transactions with each other (other than concerning the obligation).
(3) The original purchaser is not related within the meaning of section 267(b) to any of the officers or directors of the issuer, and he has not engaged in transactions with such officers or directors (other than concerning the obligation).
(4) The officers and directors of the issuer at the time of issue of the obligation are different from those in control at the time the obligation is called or the taxpayer disposes of it.
(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:
(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.
(2) Premium. For purposes of section 1232, this section, and § 1.1232-3A, premium means a purchase price which exceeds the stated redemption price of an obligation at its maturity. For purposes of the preceding sentence, if an obligation is acquired as part of an investment unit consisting of an option, security, or other property and an obligation, the purchase price of the obligation is that portion of the price paid or payable for the unit which is allocable to the obligation. The price paid for the unit shall be allocated to the individual elements of the unit on the basis of their respective fair market values. However, if the fair market value of the option, security, or other property is not readily ascertainable (within the meaning of paragraph (c) of § 1.421-6), then the price paid for the unit shall be allocated in accordance with the rules under paragraph (b)(2)(ii) of this section for allocating the initial offering price of an investment unit to its elements. If, under chapter 1 of the Code, the basis of an obligation in the hands of the holder is the same, in whole or in part, for the purposes of determining gain or loss from a sale or exchange, as the basis of the obligation in the hands of another person who purchased the obligation at a premium, then the holder shall be considered to have purchased the obligation at a premium. Thus, the donee of an obligation purchased at a premium by the doner will be considered a holder who purchased the 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:
(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.