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—
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.
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(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
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:
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(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:
(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,
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(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—
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:
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(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 |
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(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 31/2percent 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 |
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(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 21/8percent 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
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(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