Accretion and Amortization: Bond Premiums and Section 197 Intangibles

For tax purposes, accretion and amortization are the yearly adjustments that move a bond’s or intangible asset’s book value toward what it will actually be worth at the end. On a bond bought below face value, accretion adds a slice of the discount to your taxable income (or at least your basis) each year. On a bond bought above face value, amortization writes that premium back down, usually offsetting interest income along the way. On an intangible asset like goodwill or a patent, amortization spreads the purchase cost across a set number of years as a deduction. The tax rules for accretion and amortization on bonds and intangibles turn on which kind of asset you hold, when you bought it, and, for several bond situations, whether you make an election.

Accretion on Discount Bonds

Two kinds of discount get accreted, and they follow different default rules.

Original Issue Discount

If a bond is issued for less than its face value, the gap is original issue discount. The IRS treats OID as interest built into the price, so you report a portion of it as interest income each year even though no cash arrives until maturity.¹ Each year’s inclusion increases your basis, which shrinks the capital gain you’d otherwise report when the bond matures or is sold.

The annual amount has to be figured under the constant yield method: multiply the bond’s adjusted issue price at the start of the period by its yield to maturity.¹ The issuer normally sends you Form 1099-OID showing what to report.

Market Discount

Market discount arises when you buy a bond on the secondary market for less than face value, typically after rates have risen. By default, you do not report it as you go. Instead, when you sell or the bond matures, gain is taxed as ordinary income up to the amount of accrued market discount, and only the excess gets capital gain treatment.²

You can elect instead to include market discount in income annually as it accrues. The election applies to every market discount bond you acquire that year and afterward, and it can’t be revoked without Treasury consent.³ Each inclusion raises your basis, leaving less ordinary income to catch up on at the end.

There is a second reason to consider the election. If you borrow to buy a market discount bond and don’t elect current inclusion, your deduction for interest on that loan is deferred to the extent the net interest expense exceeds the accrued discount for the period.⁴ Electing current inclusion makes both Section 1276 and Section 1277 inapplicable, so the deferral doesn’t bite.

The De Minimis Threshold

Small discounts escape the accretion rules entirely. Multiply the face value by 0.25%, then by the number of complete years remaining until maturity. If the actual discount is less than that figure, it’s treated as zero, and any eventual gain is capital gain.

Take a $1,000 bond with 10 complete years to maturity. The threshold is 0.0025 × $1,000 × 10, or $25. Bought at $980, the $20 discount is below the threshold and can be ignored. Bought at $970, the $30 discount is above, and the accretion rules apply. Only complete years count, so nine years and eleven months is nine.

Amortizing a Bond Premium

Pay more than face value for a bond and you have a premium. Since you’ll only receive face value at maturity, that premium is an economic loss. Amortization spreads it across the years you hold the bond.

Taxable Bonds

For a taxable bond, amortizing the premium is your choice. If you elect it, each year’s amortization offsets the interest income the bond throws off, and your basis drops by the same amount. You make the election by claiming the offset on your return for the first year you want it, with a statement noting the election under Section 171. Once made, it applies to every taxable bond you own then or later acquire.⁵

Skip the election and you report full stated interest each year, keep your original basis, and take a capital loss when face value comes back at maturity. That is usually the worse outcome. Capital losses only offset capital gains dollar-for-dollar plus up to $3,000 of ordinary income a year, while an annual amortization offset reduces ordinary income directly.

Tax-Exempt Bonds

Municipal and other tax-exempt bonds flip the choice on its head. Premium amortization is mandatory, not elective. You must reduce your basis each year by the amortized premium, but you get no deduction, because the interest it relates to is tax-free anyway.⁵ The practical consequence is a shrinking basis, which can produce a taxable capital gain if you sell before maturity at a price above that reduced basis.

Tax-exempt OID accretes the same way taxable OID does, but you don’t include it in federal taxable income. Basis still climbs with the accretion, so a later sale reflects a higher basis and a smaller gain.⁶ Some states tax that accreted OID even though the federal government does not, so state rules deserve a check.

How the Annual Amount Is Calculated

Two methods do the arithmetic, and the choice is not really up to you.

Constant Yield for Bonds

Bond accretion and premium amortization use the constant yield method, also called the effective interest method. You first determine the yield that makes the present value of the remaining payments equal to your purchase price. For each accrual period, you multiply the bond’s adjusted basis at the start of the period by that yield. The gap between the result and the stated interest for the period is the accretion or amortization.⁷⁵

Because the adjusted basis shifts every period, the yearly adjustment shifts with it. On a discount bond, accretion amounts start small and grow. On a premium bond, amortization amounts start larger and shrink as basis approaches face value. The constant yield method is required for OID and is required for premium amortization on bonds issued after September 27, 1985.⁷

Straight-Line for Intangibles

Intangible amortization takes the straight-line route: total cost divided by useful life, the same deduction every year. It’s the required method for Section 197 intangibles and the standard approach for most other intangible amortization. Straight-line is not permitted for OID accretion or for the tax amortization of bond premiums on post-1985 issues.

Amortizing Intangible Assets

Intangibles work on a different track from bonds. Instead of adjusting toward a known face value, you’re spreading the purchase price over the years the asset is expected to produce value, the way depreciation spreads the cost of equipment.

Section 197 and the 15-Year Rule

Most intangibles acquired as part of buying a business fall under Section 197 and must be amortized straight-line over 15 years. Annual deduction equals cost divided by 15. Goodwill, covenants not to compete, trademarks, trade names, franchises, and customer lists all sit in this bucket.⁸

The 15-year term is fixed even when the asset’s real life is shorter. A five-year non-compete still amortizes over 15. Section 197 does not let you accelerate the write-off to match the actual economic life of the asset.⁹

What Section 197 Doesn’t Cover

Several intangibles are carved out. Self-created intangibles, like goodwill or customer relationships you built rather than bought, generally don’t qualify. Patents and copyrights acquired separately from a business purchase are excluded, as are interests in films, sound recordings, off-the-shelf computer software, financial interests, and land.⁸

These assets amortize over their actual useful or legal lives. A utility patent has a 20-year term from its filing date under federal law, so a patent bought eight years after filing would be written off over the 12 years remaining.

1
Internal Revenue Service. Publication 1212 – Guide to Original Issue Discount (OID) Instruments
2
Office of the Law Revision Counsel. 26 USC 1276 – Disposition Gain Representing Accrued Market Discount Treated as Ordinary Income
3
U.S. Government Publishing Office. 26 USC 1278 – Definitions and Special Rules
4
Office of the Law Revision Counsel. 26 US Code 1277 – Deferral of Interest Deduction Allocable to Accrued Market Discount
5
Internal Revenue Service. Publication 550 (2025), Investment Income and Expenses
6
Internal Revenue Service. Publication 1212 (12/2025), Guide to Original Issue Discount (OID) Instruments
7
eCFR. 26 CFR 1.171-2 – Amortization of Bond Premium
8
Office of the Law Revision Counsel. 26 US Code 197 – Amortization of Goodwill and Certain Other Intangibles
9
Internal Revenue Service. Intangibles