Bond premium is not taxable income. When you pay more than a bond’s face value, that extra amount is a cost you paid up front, and the tax code lets you recover it over the life of the bond rather than treating it as something you earned. For taxable bonds, you can elect to use the premium each year to reduce the interest income you report. For tax-exempt bonds like municipals, you’re required to work the premium off, but only against your cost basis, since the interest was never taxable to begin with.
Taxable Bonds: Premium Reduces Your Interest Income
If you buy a corporate bond or a Treasury at a premium, you can elect under IRC Section 171 to amortize that premium. Each year, a portion of the premium offsets the interest the bond pays you, and you report only the net amount as taxable interest.1Office of the Law Revision Counsel. 26 USC 171 – Amortizable Bond Premium
The math is straightforward at the reporting stage. If a bond pays you $1,000 of interest and $150 of premium is amortized for that year, you report $850 as taxable interest. The premium isn’t a separate deduction on your return. It shrinks the interest figure directly, which is more valuable than an itemized deduction would be.
Your cost basis in the bond drops by the same $150. That basis reduction matters because you paid more than face value but will only get face value back at maturity. Without the annual adjustment, you’d walk into an artificial capital loss at maturity for premium you already paid for real economic reasons. Amortization prevents that by bringing your basis down toward par over the bond’s life.2Office of the Law Revision Counsel. 26 USC 1016 – Adjustments to Basis
Sell the bond before maturity and your adjusted basis at that point drives any gain or loss. The premium you already used to offset interest is gone from a tax standpoint. You recovered it through reduced income each year, not through a loss at sale.
Making the Section 171 Election
Amortization on taxable bonds is not automatic. You elect into it by reporting the amortization on your return for the first year you want it to apply and attaching a statement that you’re electing under Section 171.3Internal Revenue Service. Publication 550 – Investment Income and Expenses
Once you elect, it applies to every taxable bond you hold at the time and every taxable bond you buy afterward. There’s no picking and choosing bond by bond. Reversing the election later requires written IRS approval through Form 3115, Application for Change in Accounting Method.4eCFR. 26 CFR 1.171-4 – Election to Amortize Bond Premium on Taxable Bonds
For most investors holding premium bonds, the election is the right call. A yearly reduction in taxable interest beats sitting on an unrealized loss until the bond matures. Just remember the scope: it’s all your taxable bonds, current and future.
Tax-Exempt Bonds: Mandatory, But Only Against Basis
Municipal bonds and other tax-exempt bonds follow a different rule. Amortizing the premium is mandatory. But because the interest is already excluded from gross income, the amortized premium has nothing to offset on the income side. Its only job is reducing your cost basis in the bond each year.1Office of the Law Revision Counsel. 26 USC 171 – Amortizable Bond Premium
Why the IRS insists on this becomes obvious with a simple example. Pay $11,000 for a $10,000 municipal bond with ten years to maturity, hold it to the end, and you get $10,000 back. Without mandatory amortization, you’d claim a $1,000 capital loss, effectively turning a premium you paid for tax-free income into a deduction against other income. The mandatory basis reduction closes that door by walking your basis from $11,000 down to $10,000 over the holding period.2Office of the Law Revision Counsel. 26 USC 1016 – Adjustments to Basis
At maturity, adjusted basis equals face value and there’s no gain or loss. Sell earlier and your basis is original cost minus the cumulative amortization to that date, and that figure determines the capital result on the sale.
What Ends Up on Your Tax Return
How this reaches your Form 1040 depends on what your brokerage reports and how it reports it.
Reading the 1099-INT
Your Form 1099-INT has several boxes tied to bond premium. Box 1 is taxable interest. Box 11 is amortizable bond premium on covered taxable bonds other than Treasuries. Box 12 is premium on Treasury obligations. Box 13 covers premium on tax-exempt bonds.5Internal Revenue Service. Form 1099-INT
Brokers have two ways of showing the numbers, and this is where mistakes happen. Some report the full gross interest in Box 1 and put the premium separately in Box 11. Others report a net interest figure in Box 1 with the premium already subtracted, and leave Box 11 blank. If Box 11 is empty on a covered premium bond, check the statement or the 1099 instructions to see which method your broker used before you touch the number.6Internal Revenue Service. Instructions for Forms 1099-INT and 1099-OID
Schedule B and the ABP Adjustment
For taxable bonds where the broker put gross interest in Box 1, you make the adjustment yourself on Schedule B. List the gross interest, then below the subtotal subtract the amortized premium and label the line “ABP Adjustment.” The net figure carries through as your taxable interest.7Internal Revenue Service. Instructions for Schedule B (Form 1040)
If the broker already netted the amount in Box 1, don’t subtract again. Double-counting the premium reduction is a common error and produces interest income that’s too low.
Tax-exempt interest doesn’t run through Schedule B in the same way, and the premium on those bonds never offsets income. So there’s nothing to subtract on the income side. What you do need is a clean running record of your adjusted basis, cut each year by the amortized amount, ready for the year you sell or the bond matures.
Basis at Sale on Form 1099-B
When you sell, the broker reports adjusted cost basis in Box 1e of Form 1099-B for covered securities. For covered bonds, the broker is required to reflect the amortized premium in that basis, so the reported figure should already be the adjusted number. For noncovered bonds, generally older acquisitions, Box 1e may be blank and the adjusted basis is yours to track and report.8Internal Revenue Service. Instructions for Form 1099-B
Two Situations Worth Knowing About
Callable bonds can shorten the amortization window. If figuring the premium to an earlier call date produces a smaller amortizable amount for the period before that call date, you have to use the call date instead of the maturity date. If the bond isn’t actually called, it’s treated as reissued at the call price and a new schedule begins for the remaining term.1Office of the Law Revision Counsel. 26 USC 171 – Amortizable Bond Premium
In some years, especially late in a bond’s life, the amortizable premium can exceed the interest paid. On a taxable bond, the excess is deductible, capped at the net interest previously included in income from that bond less the premium already deducted, and any remainder carries forward. This deduction isn’t subject to the 2% floor on miscellaneous itemized deductions.9eCFR. 26 CFR 1.171-2 – Amortization of Bond Premium On a tax-exempt bond, the same excess is a nondeductible loss and produces no tax benefit.