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Bulletin No. 1998–7
February 17, 1998

Internal Revenue

bulletin
HIGHLIGHTS
OF THIS ISSUE

These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be
relied upon as authoritative interpretations.

INCOME TAX

GIFT TAX

T.D. 8745, page 15.

Rev. Rul. 98–8, page 24.

Final regulations under section 171 of the Code relate to the
federal income tax treatment of bond premium and bond issuance premium.

Disposition of qualifying income interest. If a surviving
spouse acquires the remainder interest in a trust subject to
a QTIP election under section 2056(b)(7) of the Code in connection with the transfer by the surviving spouse of property
or cash to the holder of the remainder interest, the surviving
spouse makes a gift under sections 2511, 2512, and 2519
of the Code.

T.D. 8747, page 18.

T.D. 8743, page 26.

Final regulations under section 280B of the Code relate to
deductions available upon demolition of a building.

T.D. 8746, page 4.

Final regulations under section 1396 of the Code relate to
the period employers may use in computing the empowerment zone employment credit.

T.D. 8749, page 16.
Final regulations under section 1202 of the Code relate to
the 50-percent exclusion for gain from certain small business stock.

EXEMPT ORGANIZATIONS
Rev. Proc. 98–19, page 30.

Final regulations under section 2702 of the Code permit the
reformation of a personal residence trust or a qualified personal residence trust in order to comply with the applicable
requirements for such trusts.

T.D. 8744, page 20.
Final regulations under section 2518 of the Code relate to
the treatment of disclaimers for estate and gift tax purposes.

EMPLOYMENT TAX

Organizations excepted from reporting lobbying expenditures. This procedure provides guidance to organizations exempt from taxation under Code section 501(a) on
the application of amendments made to Code sections
162(e) and 6033(e) by section 13222 of the Omnibus Budget Reconciliation Act of 1993. Rev. Procs. 95–35 and
95–35A superseded.

Announcement 98–9, page 35.

Announcement 98–10, page 35.
A list is given of organizations now classified as private foundations.

This procedure sets forth the acceptable form of written assurances that will except the sale or exchange of a principal
residence from information reporting.

This announcement provides corrections to the 1998 Circular E, Employer’s Tax Guide (Publication 15).

ADMINISTRATIVE
Rev. Proc. 98–20, page 32.

Finding Lists begin on page 40.
Announcement of Disbarments and Suspensions begins on page 37.

Department of the Treasury
Internal Revenue Service

Mission of the Service
ucts and services; and perform in a manner warranting
the highest degree of public confidence in our integrity, efficiency, and fairness.

The purpose of the Internal Revenue Service is to collect
the proper amount of tax revenue at the least cost; serve
the public by continually improving the quality of our prod-

Statement of Principles
of Internal Revenue
Tax Administration
The Service also has the responsibility of applying and
administering the law in a reasonable, practical manner.
Issues should only be raised by examining officers when
they have merit, never arbitrarily or for trading purposes.
At the same time, the examining officer should never hesitate to raise a meritorious issue. It is also important that
care be exercised not to raise an issue or to ask a court to
adopt a position inconsistent with an established Service
position.

The function of the Internal Revenue Service is to administer the Internal Revenue Code. Tax policy for raising revenue
is determined by Congress.
With this in mind, it is the duty of the Service to carry out that
policy by correctly applying the laws enacted by Congress;
to determine the reasonable meaning of various Code provisions in light of the Congressional purpose in enacting them;
and to perform this work in a fair and impartial manner, with
neither a government nor a taxpayer point of view.

Administration should be both reasonable and vigorous. It
should be conducted with as little delay as possible and
with great courtesy and considerateness. It should never
try to overreach, and should be reasonable within the
bounds of law and sound administration. It should, however, be vigorous in requiring compliance with law and it
should be relentless in its attack on unreal tax devices and
fraud.

At the heart of administration is interpretation of the Code. It
is the responsibility of each person in the Service, charged
with the duty of interpreting the law, to try to find the true
meaning of the statutory provision and not to adopt a
strained construction in the belief that he or she is “protecting the revenue.” The revenue is properly protected only
when we ascertain and apply the true meaning of the statute.

2

Introduction
The Internal Revenue Bulletin is the authoritative instrument
of the Commissioner of Internal Revenue for announcing official rulings and procedures of the Internal Revenue Service
and for publishing Treasury Decisions, Executive Orders, Tax
Conventions, legislation, court decisions, and other items of
general interest. It is published weekly and may be obtained
from the Superintendent of Documents on a subscription
basis. Bulletin contents of a permanent nature are consolidated semiannually into Cumulative Bulletins, which are sold
on a single-copy basis.

dures must be considered, and Service personnel and others concerned are cautioned against reaching the same conclusions in other cases unless the facts and circumstances
are substantially the same.
The Bulletin is divided into four parts as follows:
Part I.—1986 Code.
This part includes rulings and decisions based on provisions
of the Internal Revenue Code of 1986.

It is the policy of the Service to publish in the Bulletin all substantive rulings necessary to promote a uniform application
of the tax laws, including all rulings that supersede, revoke,
modify, or amend any of those previously published in the
Bulletin. All published rulings apply retroactively unless otherwise indicated. Procedures relating solely to matters of internal management are not published; however, statements
of internal practices and procedures that affect the rights
and duties of taxpayers are published.

Part II.—Treaties and Tax Legislation.
This part is divided into two subparts as follows: Subpart A,
Tax Conventions, and Subpart B, Legislation and Related
Committee Reports.
Part III.—Administrative, Procedural, and Miscellaneous.
To the extent practicable, pertinent cross references to
these subjects are contained in the other Parts and Subparts. Also included in this part are Bank Secrecy Act Administrative Rulings. Bank Secrecy Act Administrative Rulings
are issued by the Department of the Treasury’s Office of the
Assistant Secretary (Enforcement).

Revenue rulings represent the conclusions of the Service on
the application of the law to the pivotal facts stated in the
revenue ruling. In those based on positions taken in rulings
to taxpayers or technical advice to Service field offices,
identifying details and information of a confidential nature
are deleted to prevent unwarranted invasions of privacy and
to comply with statutory requirements.

Part IV.—Items of General Interest.
With the exception of the Notice of Proposed Rulemaking
and the disbarment and suspension list included in this part,
none of these announcements are consolidated in the Cumulative Bulletins.

Rulings and procedures reported in the Bulletin do not have
the force and effect of Treasury Department Regulations,
but they may be used as precedents. Unpublished rulings
will not be relied on, used, or cited as precedents by Service
personnel in the disposition of other cases. In applying published rulings and procedures, the effect of subsequent legislation, regulations, court decisions, rulings, and proce-

The first Bulletin for each month includes a cumulative index
for the matters published during the preceding months.
These monthly indexes are cumulated on a semiannual basis
and are published in the first Bulletin of the succeeding semiannual period, respectively.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.
For sale by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.

3

Part I. Rulings and Decisions Under the Internal Revenue Code of 1986
Section 121.—Exclusion of Gain
From Sale of Principal Residence
Guidance is provided on the acceptable form of
written assurances (certification) that a real estate
reporting person must obtain from the seller of a
principal residence to except such sale or exchange
from the information reporting requirements for real
estate transactions under section 6045(e)(5). See
Rev. Proc. 98–20, page 32.

Section 162.—Trade or Business
Expenses
26 CFR 1.162–20: Expenditures attributable to
lobbying, political campaigns, attempts to influence
legislation, etc., and certain advertising.
This revenue procedure provides guidance to organizations exempt from taxation under § 501(a) of
the Internal Revenue Code of 1986 on the application of amendments made to §§ 162(e) and 6033(e)
by § 13222 of the Omnibus Budget Reconciliation
Act of 1993. The revenue procedure identifies certain tax-exempt organizations that will be treated as
satisfying the requirements of § 6033(e)(3). Those
organizations will not be subject to the reporting and
notice requirements of § 6033(e)(1) or the tax imposed by § 6033(e)(2). Procedures for other exempt
organizations to establish that they satisfy the requirements of § 6033(e)(3) are also provided. Rev.
Proc. 95–35, 1995–2 C.B. 391, and Rev. Proc.
95–35A, 1995–2 C.B. 392, are superseded. See Rev.
Proc. 98–19, page 30.

Section 171.—Amortizable Bond
Premium
26 CFR 1.171: Bond premium.

T.D. 8746
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
Amortizable Bond Premium
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains
final regulations relating to the federal income tax treatment of bond premium and
bond issuance premium. The regulations
reflect changes to the law made by the
Tax Reform Act of 1986 and the Techni-

February 17, 1998

cal and Miscellaneous Revenue Act of
1988. The regulations will provide
needed guidance to holders and issuers of
debt instruments.
DATES: Effective Date: March 2, 1998.
Applicability date: For dates of applicability of the final regulations, see Effective Dates under SUPPLEMENTARY
INFORMATION.
FOR FURTHER INFORMATION CONTACT: William E. Blanchard, (202) 6223950 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collections of information contained in these final regulations have been
reviewed and approved by the Office of
Management and Budget in accordance
with the requirements of the Paperwork
Reduction Act of 1995 (44 U.S.C.
3507(d)) under control number 15451491. Responses to these collections of
information are required by the IRS to determine whether a holder of a bond has
elected to amortize bond premium and
whether an issuer or a holder has changed
its method of accounting for premium.
An agency may not conduct or sponsor,
and a person is not required to respond to,
a collection of information unless the collection of information displays a valid
control number.
The estimated annual burden per respondent varies from 0.25 hours to 0.75
hours, depending on individual circumstances, with an estimated average of 0.5
hours.
Comments concerning the accuracy of
this burden estimate and suggestions for
reducing this burden should be sent to the
Internal Revenue Service, Attn: IRS
Reports Clearance Officer, T:FP, Washington, DC 20224, and to the Office of
Management and Budget, Attn: Desk
Officer for the Department of Treasury,
Office of Information and Regulatory Affairs, Washington, DC 20503.
Books or records relating to the collections of information must be retained as
long as their contents may become material in the administration of any internal
revenue law. Generally, tax returns and

4

tax return information are confidential, as
required by 26 U.S.C. 6103.
Background
Sections 1.171-1 through 1.171-4 of
the Income Tax Regulations were promulgated in 1957 and last amended in 1968.
In the Tax Reform Act of 1986, section
171(b) was amended to require that bond
premium be amortized by reference to a
constant yield. In the Technical and Miscellaneous Revenue Act of 1988, section
171(e) was amended to require that amortizable bond premium be treated as an offset to interest income.
On June 27, 1996, the IRS published a
notice of proposed rulemaking in the Federal Register (61 F.R. 33396 [FI–48–95,
1996–2 C.B. 449]) relating to the federal
income tax treatment of bond premium
and bond issuance premium. A public
hearing was not held because no one requested to speak at the hearing that had
been scheduled for October 23, 1996.
The IRS did receive a few comments on
the proposed regulations. The proposed
regulations, with certain changes to respond to the comments, are adopted as
final regulations.
Explanation of Provisions
In general, bond premium arises when a
holder acquires a bond for more than the
principal amount of the bond. Similarly,
bond issuance premium arises when an issuer issues a bond for more than the principal amount of the bond. A holder will purchase, and an issuer will issue, a bond for
more than its principal amount when the
stated interest rate on the bond is higher
than the current market yield for the bond.
The holder’s treatment of bond premium
is addressed in §§1.171–1 through
1.171–5. The issuer’s treatment of bond
issuance premium is addressed in §1.163–
13. In each case, the amortization of premium is based on constant yield principles.
For this reason, the final regulations use
concepts and definitions from the original
issue discount (OID) regulations (in general, see §§1.1271–1 through 1.1275–7T).
Determination of Bond Premium
Under the proposed regulations, bond
premium is defined as the excess of a

1998–7 I.R.B.

holder’s basis in a bond over the sum of
the remaining amounts payable on the
bond other than payments of qualified
stated interest. The holder generally determines the amount of bond premium as
of the date the holder acquires the bond.
The proposed regulations provide special rules that limit a holder’s basis solely
for purposes of determining bond premium. For example, if a bond is convertible into stock of the issuer at the holder’s
option, for purposes of determining bond
premium, the holder must reduce its basis
in the bond by the value of the conversion
option. This reduction prevents the
holder from inappropriately amortizing
the cost of the embedded conversion
option.
The final regulations adopt the rules of
the proposed regulations for determining
the amount of bond premium, if any, on a
bond. However, in response to comments, the final regulations clarify the determination of basis in the case of a convertible bond acquired in a transferred
basis transaction.
Amortization of Bond Premium
(a) In general
Under section 171, the holder of a taxable bond acquired at a premium may
elect to amortize bond premium. The
holder of a tax-exempt bond acquired at a
premium must amortize the premium. As
premium is amortized, the holder’s basis
in the bond is reduced by a corresponding
amount under section 1016(a)(5).
Under the proposed regulations, a
holder amortizes bond premium by offsetting qualified stated interest income with
bond premium. An offset is calculated for
each accrual period using constant yield
principles. However, the offset for an accrual period is only taken into account
when the holder takes qualified stated interest into account under the holder’s regular method of accounting. Thus, a holder
using the cash receipts and disbursements
method of accounting does not take bond
premium into account until a qualified
stated interest payment is received.
The final regulations adopt the rules in
the proposed regulations for amortizing
bond premium.
(b) Excess premium
For certain bonds (for example, bonds
that pay a variable rate of interest or that

1998–7 I.R.B

provide for an interest holiday), the
amount of bond premium allocable to an
accrual period could exceed the amount
of qualified stated interest allocable to
that period. The proposed regulations address this situation by providing that the
excess bond premium is not allowed as a
deduction but is carried forward to future
accrual periods.
Several commentators stated that this
excess premium should be allowable as a
current deduction for the accrual period in
which the excess occurs. In response to
these comments, the final regulations
adopt rules for excess premium that are
similar to the rules for negative adjustments on contingent payment debt instruments and deflation adjustments on inflation-indexed debt instruments. Under the
final regulations, any excess bond premium allocable to an accrual period is deductible by the holder under section
171(a)(1) for the accrual period. The
amount deductible, however, is limited by
the amount of the holder’s prior income
inclusions on the bond. If any of the excess bond premium is not deductible
under section 171(a)(1), this amount is
carried forward to the next accrual period
and is treated as bond premium allocable
to that period.
Bonds Subject to Certain Contingencies
If a bond provides for one or more alternative payment schedules, the yield of
the bond cannot be determined without
making assumptions about the actual payment schedule. The OID regulations provide rules for making these assumptions.
For example, the rules assume that an issuer will exercise a call option if doing so
would minimize the yield of the debt instrument and that a holder will exercise a
put option if doing so would maximize
the yield of the debt instrument.
The proposed regulations under section
171 generally use similar assumptions to
determine the holder’s yield on a bond
that provides for alternative payment
schedules. However, in the case of an issuer’s option on a taxable bond, the proposed regulations reverse the assumption
in the OID regulations by assuming that
the issuer will exercise the option only if
doing so would increase the yield on the
bond. See section 171(b)(1)(B)(ii). Thus,
under the proposed regulations, a holder
generally must amortize bond premium

5

on a taxable bond by reference to the
stated maturity date, even if it appears
likely the bond will be called. In this
case, if the bond is actually called, the
proposed regulations provide that the
holder may deduct the unamortized premium. If the bond is partially called and
the partial call is not a pro-rata prepayment, the proposed regulations do not
allow the holder to deduct a portion of the
unamortized premium. Instead, the
holder must recompute the yield of the
bond on the date of the partial call and
amortize the remaining premium by reference to the recomputed yield.
In general, the final regulations adopt
the rules of the proposed regulations. In
response to a comment, the final regulations limit the issuer rule for taxable
bonds to call options.
Bond Issuance Premium
Under existing §1.61–12(c), a corporate issuer treats premium received upon
issuance of a bond as a separate item of
income. Over the term of the bond, the
premium is taken into income, and the
full amount of the stated interest is deducted. The proposed regulations revise
the treatment of bond issuance premium.
Under the proposed regulations, bond issuance premium is amortized as an offset
to the issuer’s otherwise allowable interest deduction, not as a separate item of income. The amount of bond issuance premium amortized in any period is based on
a constant yield. In addition, the proposed regulations apply to all issuers, not
just corporate issuers.
In general, the final regulations adopt
the rules in the proposed regulations for
bond issuance premium. However, the
final regulations contain several important changes from the proposed regulations. First, in response to comments, the
final regulations clarify the treatment of a
debt instrument subject to an alternative
payment schedule by explicitly cross-referencing §1.1272–1(c). Second, the final
regulations provide that, in the case of a
debt instrument subject to a mandatory
sinking fund provision, the issuer must
determine the payment schedule by assuming that a pro rata portion of the debt
instrument will be called under the sinking fund provision. This rule produces
more economic interest accruals than the

February 17, 1998

accruals determined by ignoring the sinking fund provision as under the proposed
regulations. Third, the final regulations
adopt rules for excess bond issuance premium allocable to an accrual period.
These rules are similar to the rules for excess bond premium described above.
Aggregation Rules
Although the proposed regulations do
not provide for an aggregate method of
accounting for premium, comments were
requested on the need for an aggregate
method. Because no comments were received, the final regulations do not provide rules for an aggregate method of accounting for premium.
Bonds Not Subject to the Final
Regulations
The final regulations generally apply to
bonds acquired or issued at a premium.
Certain bonds, however, are excluded
from the application of the final regulations. For example, the final regulations
exclude debt instruments described in
section 1272(a)(6)(C) (regular interests in
a REMIC, qualified mortgages held by a
REMIC, and certain other debt instruments, or pools of debt instruments, with
payments subject to acceleration). No inference is intended regarding the treatment of debt instruments described in section 1272(a)(6)(C).
Effective Dates
The final regulations relating to bond
premium are effective for bonds acquired
on or after March 2, 1998. However, if a
holder makes the election to amortize
bond premium for the taxable year containing March 2, 1998, or any subsequent
taxable year, the regulations apply to
bonds held on or after the first day of the
taxable year in which the election is
made.
The final regulations relating to bond
issuance premium apply to debt instruments issued on or after March 2, 1998.
The final regulations also provide automatic consent for a taxpayer to change its
method of accounting for premium in certain circumstances. Because the change
is made on a cut-off basis, no items of income or deduction are omitted or duplicated. Therefore, no adjustment under
section 481 is allowed.

February 17, 1998

Special Analyses
It is hereby certified that these regulations do not have significant economic
impact on a substantial number of small
entities. This certification is based upon
the fact that the regulations merely require a taxpayer to attach to the taxpayer’s return a statement that indicates
whether the taxpayer is making an election under section 171 or is changing its
accounting method for bond premium or
bond issuance premium. Therefore, a
Regulatory Flexibility Analysis under the
Regulatory Flexibility Act (5 U.S.C.
chapter 6) is not required.
It has been determined that this Treasury Decision is not a significant regulatory action as defined in EO 12866.
Therefore, a regulatory assessment is not
required. It has also been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not
apply to these regulations. Pursuant to
section 7805(f) of the Internal Revenue
Code, the notice of proposed rulemaking
was submitted to the Chief Counsel for
Advocacy of the Small Business Administration for comment on its impact on
small business.
Drafting Information
Several persons from the Office of Assistant Chief Counsel (Financial Institutions and Products) and the Treasury Department participated in the development
of these regulations.
*

*

*

*

*

Adoption of Amendments to the
Regulations
Accordingly, 26 CFR parts 1 and 602
are amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 is amended by adding entries in numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.171–2 also issued under 26
U.S.C. 171(e).
Section 1.171–3 also issued under 26
U.S.C. 171(e).
Section 1.171–4 also issued under 26
U.S.C. 171(c). * * *
Par. 2. Section 1.61–12 is amended by
revising paragraph (c) to read as follows:

6

§1.61–12 Income from discharge of
indebtedness.
* * * * *
(c) Issuance and repurchase of debt instruments—(1) Issuance. An issuer does
not realize gain or loss upon the issuance
of a debt instrument. For rules relating to
an issuer’s interest deduction for a debt
instrument issued with bond issuance premium, see §1.163–13.
(2) Repurchase—(i) In general. An issuer does not realize gain or loss upon the
repurchase of a debt instrument. However, if a debt instrument provides for
payments denominated in, or determined
by reference to, a nonfunctional currency,
an issuer may realize a currency gain or
loss upon the repurchase of the instrument. See section 988 and the regulations
thereunder. For purposes of this paragraph (c)(2), the term repurchase includes
the retirement of a debt instrument, the
conversion of a debt instrument into stock
of the issuer, and the exchange (including
an exchange under section 1001) of a
newly issued debt instrument for an existing debt instrument.
(ii) Repurchase at a discount. An issuer realizes income from the discharge
of indebtedness upon the repurchase of a
debt instrument for an amount less than
its adjusted issue price (within the meaning of §1.1275–1(b)). The amount of discharge of indebtedness income is equal to
the excess of the adjusted issue price over
the repurchase price. See section 108 and
the regulations thereunder for additional
rules relating to income from discharge of
indebtedness. For example, to determine
the repurchase price of a debt instrument
that is repurchased through the issuance
of a new debt instrument, see section
108(e)(10).
(iii) Repurchase at a premium. An issuer may be entitled to a repurchase premium deduction upon the repurchase of a
debt instrument for an amount greater than
its adjusted issue price (within the meaning
of §1.1275–1(b)). See §1.163– 7(c) for the
treatment of repurchase premium.
(iv) Effective date. This paragraph
(c)(2) applies to debt instruments repurchased on or after March 2, 1998.
* * * * *
Par. 3. Section 1.163-13 is added to
read as follows:

1998–7 I.R.B.

§1.163–13 Treatment of bond issuance
premium.
(a) General rule. If a debt instrument
is issued with bond issuance premium,
this section limits the amount of the issuer’s interest deduction otherwise allowable under section 163(a). In general, the
issuer determines its interest deduction by
offsetting the interest allocable to an accrual period with the bond issuance premium allocable to that period. Bond issuance premium is allocable to an accrual
period based on a constant yield. The use
of a constant yield to amortize bond issuance premium is intended to generally
conform the treatment of debt instruments
having bond issuance premium with those
having original issue discount. Unless
otherwise provided, the terms used in this
section have the same meaning as those
terms in section 163(e), sections 1271
through 1275, and the corresponding regulations. Moreover, unless otherwise provided, the provisions of this section apply
in a manner consistent with those of section 163(e), sections 1271 through 1275,
and the corresponding regulations. In addition, the anti-abuse rule in §1.1275–2(g)
applies for purposes of this section. For
rules dealing with the treatment of bond
premium by a holder, see §§1.171–1
through 1.171–5.
(b) Exceptions. This section does not
apply to—
(1) A debt instrument described in section 1272(a)(6)(C) (regular interests in a
REMIC, qualified mortgages held by a
REMIC, and certain other debt instruments, or pools of debt instruments, with
payments subject to acceleration); or
(2) A debt instrument to which
§1.1275–4 applies (relating to certain
debt instruments that provide for contingent payments).
(c) Bond issuance premium. Bond issuance premium is the excess, if any, of
the issue price of a debt instrument over
its stated redemption price at maturity.
For purposes of this section, the issue
price of a convertible bond (as defined in
§1.171–1(e)(1)(iii)(C)) does not include
an amount equal to the value of the conversion option (as determined under
§1.171–1(e)(1)(iii)(A)).
(d) Offsetting qualified stated interest
with bond issuance premium—(1) In general. An issuer amortizes bond issuance
premium by offsetting the qualified stated

1998–7 I.R.B

interest allocable to an accrual period
with the bond issuance premium allocable
to the accrual period. This offset occurs
when the issuer takes the qualified stated
interest into account under its regular
method of accounting.
(2) Qualified stated interest allocable
to an accrual period. See §1.446–2(b) to
determine the accrual period to which
qualified stated interest is allocable and to
determine the accrual of qualified stated
interest within an accrual period.
(3) Bond issuance premium allocable
to an accrual period. The bond issuance
premium allocable to an accrual period is
determined under this paragraph (d)(3).
Within an accrual period, the bond issuance premium allocable to the period
accrues ratably.
(i) Step one: Determine the debt instrument’s yield to maturity. The yield to
maturity of a debt instrument is determined under the rules of §1.1272–1(b)(1)(i).
(ii) Step two: Determine the accrual
periods. The accrual periods are determined under the rules of §1.1272–1(b)(1)(ii).
(iii) Step three: Determine the bond issuance premium allocable to the accrual
period. The bond issuance premium allocable to an accrual period is the excess of
the qualified stated interest allocable to
the accrual period over the product of the
adjusted issue price at the beginning of
the accrual period and the yield. In performing this calculation, the yield must be
stated appropriately taking into account
the length of the particular accrual period.
Principles similar to those in §1.1272–
1(b)(4) apply in determining the bond issuance premium allocable to an accrual
period.
(4) Bond issuance premium in excess of
qualified stated interest—(i) Ordinary income. If the bond issuance premium allocable to an accrual period exceeds the
qualified stated interest allocable to the
accrual period, the excess is treated as ordinary income by the issuer for the accrual period. However, the amount
treated as ordinary income is limited to
the amount by which the issuer’s total interest deductions on the debt instrument
in prior accrual periods exceed the total
amount treated by the issuer as ordinary
income on the debt instrument in prior accrual periods.

7

(ii) Carryforward. If the bond issuance
premium allocable to an accrual period
exceeds the sum of the qualified stated interest allocable to the accrual period and
the amount treated as ordinary income for
the accrual period under paragraph
(d)(4)(i) of this section, the excess is carried forward to the next accrual period
and is treated as bond issuance premium
allocable to that period. If a carryforward
exists on the date the debt instrument is
retired, the carryforward is treated as ordinary income on that date.
(e) Special rules—(1) Variable rate
debt instruments. An issuer determines
bond issuance premium on a variable rate
debt instrument by reference to the stated
redemption price at maturity of the equivalent fixed rate debt instrument constructed for the variable rate debt instrument. The issuer also allocates any bond
issuance premium among the accrual periods by reference to the equivalent fixed
rate debt instrument. The issuer constructs the equivalent fixed rate debt instrument, as of the issue date, by using the
principles of §1.1275–5(e).
(2) Inflation-indexed debt instruments.
An issuer determines bond issuance premium on an inflation-indexed debt instrument by assuming that there will be no inflation or deflation over the term of the
instrument. The issuer also allocates any
bond issuance premium among the accrual
periods by assuming that there will be no
inflation or deflation over the term of the
instrument. The bond issuance premium
allocable to an accrual period offsets qualified stated interest allocable to the period.
Notwithstanding paragraph (d)(4) of this
section, if the bond issuance premium allocable to an accrual period exceeds the
qualified stated interest allocable to the
period, the excess is treated as a deflation
adjustment under §1.1275–7T(f)(1)(ii).
See §1.1275–7T for other rules relating to
inflation-indexed debt instruments.
(3) Certain debt instruments subject to
contingencies—(i) In general. Except as
provided in paragraph (e)(3)(ii) of this
section, the rules of §1.1272–1(c) apply to
determine a debt instrument’s payment
schedule for purposes of this section. For
example, an issuer uses the payment
schedule determined under §1.1272–1(c)
to determine the amount, if any, of bond
issuance premium on the debt instrument,
the yield and maturity of the debt instru-

February 17, 1998

ment, and the allocation of bond issuance
premium to an accrual period.
(ii) Mandatory sinking fund provision.
Notwithstanding paragraph (e)(3)(i) of
this section, if a debt instrument is subject
to a mandatory sinking fund provision described in §1.1272–1(c)(3), the issuer
must determine the payment schedule by
assuming that a pro rata portion of the
debt instrument will be called under the
sinking fund provision.
(4) Remote and incidental contingencies. For purposes of determining the
amount of bond issuance premium and allocating bond issuance premium among
accrual periods, if a bond provides for a
contingency that is remote or incidental
(within the meaning of §1.1275–2(h)), the
issuer takes the contingency into account
under the rules for remote and incidental
contingencies in §1.1275–2(h).
(f) Example. The following example illustrates the rules of this section:
Example—(i) Facts. On February 1, 1999, X issues for $110,000 a debt instrument maturing on
February 1, 2006, with a stated principal amount of
$100,000, payable at maturity. The debt instrument
provides for unconditional payments of interest of
$10,000, payable on February 1 of each year. X uses
the calendar year as its taxable year, X uses the cash
receipts and disbursements method of accounting,
and X decides to use annual accrual periods ending
on February 1 of each year. X’s calculations assume
a 30-day month and 360-day year.
(ii) Amount of bond issuance premium. The issue
price of the debt instrument is $110,000. Because
the interest payments on the debt instrument are
qualified stated interest, the stated redemption price
at maturity of the debt instrument is $100,000.
Therefore, the amount of bond issuance premium is
$10,000 ($110,000–$100,000).
(iii) Bond issuance premium allocable to the first
accrual period. Based on the payment schedule and
the issue price of the debt instrument, the yield of the
debt instrument is 8.07 percent, compounded annually. (Although, for purposes of simplicity, the yield
as stated is rounded to two decimal places, the computations do not reflect this rounding convention.)
The bond issuance premium allocable to the accrual
period ending on February 1, 2000, is the excess of
the qualified stated interest allocable to the period
($10,000) over the product of the adjusted issue price
at the beginning of the period ($110,000) and the
yield (8.07 percent, compounded annually). Therefore, the bond issuance premium allocable to the accrual period is $1,118.17 ($10,000– $8,881.83).
(iv) Premium used to offset interest. Although X
makes an interest payment of $10,000 on February
1, 2000, X only deducts interest of $8,881.83, the
qualified stated interest allocable to the period
($10,000) offset with the bond issuance premium allocable to the period ($1,118.17).

(g) Effective date. This section applies
to debt instruments issued on or after
March 2, 1998.

February 17, 1998

(h) Accounting method changes—(1)
Consent to change. An issuer required to
change its method of accounting for bond
issuance premium to comply with this
section must secure the consent of the
Commissioner in accordance with the requirements of §1.446–1(e). Paragraph
(h)(2) of this section provides the Commissioner’s automatic consent for certain
changes.
(2) Automatic consent. The Commissioner grants consent for an issuer to
change its method of accounting for bond
issuance premium on debt instruments issued on or after March 2, 1998. Because
this change is made on a cut-off basis, no
items of income or deduction are omitted
or duplicated and, therefore, no adjustment under section 481 is allowed. The
consent granted by this paragraph (h)(2)
applies provided—
(i) The change is made to comply with
this section;
(ii) The change is made for the first taxable year for which the issuer must account for a debt instrument under this section; and
(iii) The issuer attaches to its federal income tax return for the taxable year containing the change a statement that it has
changed its method of accounting under
this section.
Par. 4. Sections 1.171-1 through 1.1714 are revised to read as follows:
§1.171–1 Bond premium.
(a) Overview—(1) In general. This
section and §§1.171–2 through 1.171–5
provide rules for the determination and
amortization of bond premium by a
holder. In general, a holder amortizes
bond premium by offsetting the interest
allocable to an accrual period with the
premium allocable to that period. Bond
premium is allocable to an accrual period
based on a constant yield. The use of a
constant yield to amortize bond premium
is intended to generally conform the treatment of bond premium to the treatment of
original issue discount under sections
1271 through 1275. Unless otherwise
provided, the terms used in this section
and §§1.171–2 through 1.171–5 have the
same meaning as those terms in sections
1271 through 1275 and the corresponding
regulations. Moreover, unless otherwise
provided, the provisions of this section
and §§1.171–2 through 1.171–5 apply in

8

a manner consistent with those of sections
1271 through 1275 and the corresponding
regulations. In addition, the anti-abuse
rule in §1.1275–2(g) applies for purposes
of this section and §§1.171–2 through
1.171–5.
(2) Cross-references. For rules dealing
with the adjustments to a holder’s basis to
reflect the amortization of bond premium,
see §1.1016–5(b). For rules dealing with
the treatment of bond issuance premium
by an issuer, see §1.163–13.
(b) Scope—(1) In general. Except as
provided in paragraph (b)(2) of this section and §1.171–5, this section and
§§1.171–2 through 1.171–4 apply to any
bond that, upon its acquisition by the
holder, is held with bond premium. For
purposes of this section and §§1.171–2
through 1.171–5, the term bond has the
same meaning as the term debt instrument
in §1.1275–1(d).
(2) Exceptions. This section and
§§1.171–2 through 1.171–5 do not apply
to—
(i) A bond described in section 1272(a)(6)(C) (regular interests in a REMIC,
qualified mortgages held by a REMIC,
and certain other debt instruments, or
pools of debt instruments, with payments
subject to acceleration);
(ii) A bond to which §1.1275–4 applies
(relating to certain debt instruments that
provide for contingent payments);
(iii) A bond held by a holder that has
made a §1.1272–3 election with respect to
the bond;
(iv) A bond that is stock in trade of the
holder, a bond of a kind that would properly be included in the inventory of the
holder if on hand at the close of the taxable year, or a bond held primarily for
sale to customers in the ordinary course of
the holder’s trade or business; or
(v) A bond issued before September 28,
1985, unless the bond bears interest and
was issued by a corporation or by a government or political subdivision thereof.
(c) General rule—(1) Tax-exempt
obligations. A holder must amortize bond
premium on a bond that is a tax-exempt
obligation. See §1.171–2(c) Example 4.
(2) Taxable bonds. A holder may elect
to amortize bond premium on a taxable
bond. Except as provided in paragraph
(c)(3) of this section, a taxable bond is
any bond other than a tax-exempt obligation. See §1.171–4 for rules relating to

1998–7 I.R.B.

the election to amortize bond premium on
a taxable bond.
(3) Bonds the interest on which is partially excludable. For purposes of this
section and §§1.171–2 through 1.171–5, a
bond the interest on which is partially excludable from gross income is treated as
two instruments, a tax-exempt obligation
and a taxable bond. The holder’s basis in
the bond and each payment on the bond
are allocated between the two instruments
based on a reasonable method.
(d) Determination of bond premium—
(1) In general. A holder acquires a bond
at a premium if the holder’s basis in the
bond immediately after its acquisition by
the holder exceeds the sum of all amounts
payable on the bond after the acquisition
date (other than payments of qualified
stated interest). This excess is bond premium, which is amortizable under
§1.171–2.
(2) Additional rules for amounts
payable on certain bonds. Additional
rules apply to determine the amounts
payable on a variable rate debt instrument, an inflation-indexed debt instrument, a bond that provides for certain alternative payment schedules, and a bond
that provides for remote or incidental contingencies. See §1.171–3.
(e) Basis. A holder determines its basis
in a bond under this paragraph (e). This
determination of basis applies only for
purposes of this section and §§1.171–2
through 1.171–5. Because of the application of this paragraph (e), the holder’s
basis in the bond for purposes of these
sections may differ from the holder’s
basis for determining gain or loss on the
sale or exchange of the bond.
(1) Determination of basis—(i) In general. In general, the holder’s basis in the
bond is the holder’s basis for determining
loss on the sale or exchange of the bond.
(ii) Bonds acquired in certain exchanges. If the holder acquired the bond
in exchange for other property (other than
in a reorganization defined in section 368)
and the holder’s basis in the bond is determined in whole or in part by reference to
the holder’s basis in the other property,
the holder’s basis in the bond may not exceed its fair market value immediately
after the exchange. See paragraph (f) Example 1 of this section. If the bond is acquired in a reorganization, see section
171(b)(4)(B).

1998–7 I.R.B

(iii) Convertible bonds—(A) General
rule. If the bond is a convertible bond,
the holder’s basis in the bond is reduced
by an amount equal to the value of the
conversion option. The value of the conversion option may be determined under
any reasonable method. For example, the
holder may determine the value of the
conversion option by comparing the market price of the convertible bond to the
market prices of similar bonds that do not
have conversion options. See paragraph
(f) Example 2 of this section.
(B) Convertible bonds acquired in certain exchanges. If the bond is a convertible bond acquired in a transaction described in paragraph (e)(1)(ii) of this
section, the holder’s basis in the bond
may not exceed its fair market value immediately after the exchange reduced by
the value of the conversion option.
(C) Definition of convertible bond. A
convertible bond is a bond that provides
the holder with an option to convert the
bond into stock of the issuer, stock or debt
of a related party (within the meaning of
section 267(b) or 707(b)(1)), or into cash
or other property in an amount equal to the
approximate value of such stock or debt.
(2) Basis in bonds held by certain
transferees. Notwithstanding paragraph
(e)(1) of this section, if the bond is transferred basis property (as defined in section 7701(a)(43)) and the transferor had
acquired the bond at a premium, the
holder’s basis in the bond is—
(i) The holder’s basis for determining
loss on the sale or exchange of the bond;
reduced by
(ii) Any amounts that the transferor
could not have amortized under this paragraph (e) or under §1.171–4(c), except to
the extent that the holder’s basis already
reflects a reduction attributable to such
nonamortizable amounts.
(f) Examples. The following examples
illustrate the rules of this section:
Example 1. Bond received in liquidation of a
partnership interest—(i) Facts. PR is a partner in
partnership PRS. PRS does not have any unrealized
receivables or inventory items as defined in section
751. On January 1, 1998, PRS distributes to PR a
taxable bond, issued by an unrelated corporation, in
liquidation of PR’s partnership interest. At that
time, the fair market value of PR’s partnership interest is $40,000 and the basis is $100,000. The fair
market value of the bond is $40,000.
(ii) Determination of basis. Under section
732(b), PR’s basis in the bond is equal to PR’s basis
in the partnership interest. Therefore, PR’s basis for

9

determining loss on the sale or exchange of the bond
is $100,000. However, because the distribution is
treated as an exchange for purposes of section
171(b)(4), PR’s basis in the bond is $40,000 for purposes of this section and §§1.171–2 through 1.171–
5. See paragraph (e)(1)(ii) of this section.
Example 2. Convertible bond—(i) Facts. On
January 1, 1998, A purchases for $1,100 B corporation’s bond maturing on January 1, 2001, with a
stated principal amount of $1,000, payable at maturity. The bond provides for unconditional payments
of interest of $30 on January 1 and July 1 of each
year. In addition, the bond is convertible into 15
shares of B corporation stock at the option of the
holder. On January 1, 1998, B corporation’s nonconvertible, publicly-traded, three-year debt with a
similar credit rating trades at a price that reflects a
yield of 6.75 percent, compounded semiannually.
(ii) Determination of basis. A’s basis for determining loss on the sale or exchange of the bond is
$1,100. As of January 1, 1998, discounting the remaining payments on the bond at the yield at which
B’s similar nonconvertible bonds trade (6.75 percent, compounded semiannually) results in a present
value of $980. Thus, the value of the conversion option is $120. Under paragraph (e)(1)(iii)(A) of this
section, A’s basis is $980 ($1,100–$120) for purposes of this section and §§1.171–2 through 1.171–
5. The sum of all amounts payable on the bond
other than qualified stated interest is $1,000. Because A’s basis (as determined under paragraph
(e)(1)(iii)(A) of this section) does not exceed
$1,000, A does not acquire the bond at a premium.

§1.171–2 Amortization of bond premium.
(a) Offsetting qualified stated interest
with premium—(1) In general. A holder
amortizes bond premium by offsetting the
qualified stated interest allocable to an accrual period with the bond premium allocable to the accrual period. This offset
occurs when the holder takes the qualified
stated interest into account under the
holder’s regular method of accounting.
(2) Qualified stated interest allocable
to an accrual period. See §1.446–2(b) to
determine the accrual period to which
qualified stated interest is allocable and to
determine the accrual of qualified stated
interest within an accrual period.
(3) Bond premium allocable to an accrual period. The bond premium allocable to an accrual period is determined
under this paragraph (a)(3). Within an accrual period, the bond premium allocable
to the period accrues ratably.
(i) Step one: Determine the holder’s
yield. The holder’s yield is the discount
rate that, when used in computing the present value of all remaining payments to be
made on the bond (including payments of
qualified stated interest), produces an
amount equal to the holder’s basis in the

February 17, 1998

bond as determined under §1.171–1(e).
For this purpose, the remaining payments
include only payments to be made after
the date the holder acquires the bond.
The yield is calculated as of the date the
holder acquires the bond, must be constant over the term of the bond, and must
be calculated to at least two decimal
places when expressed as a percentage.
(ii) Step two: Determine the accrual
periods. A holder determines the accrual
periods for the bond under the rules of
§1.1272–1(b)(1)(ii).
(iii) Step three: Determine the bond
premium allocable to the accrual period.
The bond premium allocable to an accrual
period is the excess of the qualified stated
interest allocable to the accrual period
over the product of the holder’s adjusted
acquisition price (as defined in paragraph
(b) of this section) at the beginning of the
accrual period and the holder’s yield. In
performing this calculation, the yield must
be stated appropriately taking into account
the length of the particular accrual period.
Principles similar to those in §1.1272–
1(b)(4) apply in determining the bond premium allocable to an accrual period.
(4) Bond premium in excess of qualified stated interest—(i) Taxable bonds—
(A) Bond premium deduction. In the case
of a taxable bond, if the bond premium allocable to an accrual period exceeds the
qualified stated interest allocable to the
accrual period, the excess is treated by the
holder as a bond premium deduction
under section 171(a)(1) for the accrual period. However, the amount treated as a
bond premium deduction is limited to the
amount by which the holder’s total interest inclusions on the bond in prior accrual
periods exceed the total amount treated by
the holder as a bond premium deduction
on the bond in prior accrual periods. A
deduction determined under this paragraph (a)(4)(i)(A) is not subject to section
67 (the 2-percent floor on miscellaneous
itemized deductions). See Example 1 of
§1.171–3(e).
(B) Carryforward. If the bond premium
allocable to an accrual period exceeds the
sum of the qualified stated interest allocable to the accrual period and the amount
treated as a deduction for the accrual period under paragraph (a)(4)(i)(A) of this
section, the excess is carried forward to the
next accrual period and is treated as bond
premium allocable to that period.

February 17, 1998

(ii) Tax-exempt obligations. In the case
of a tax-exempt obligation, if the bond
premium allocable to an accrual period
exceeds the qualified stated interest allocable to the accrual period, the excess is a
nondeductible loss. If a regulated investment company (RIC) within the meaning
of section 851 has excess bond premium
for an accrual period that would be a
nondeductible loss under the prior sentence, the RIC must use this excess bond
premium to reduce its tax-exempt interest
income on other tax-exempt obligations
held during the accrual period.
(5) Additional rules for certain bonds.
Additional rules apply to determine the
amortization of bond premium on a variable rate debt instrument, an inflation-indexed debt instrument, a bond that provides for certain alternative payment
schedules, and a bond that provides for
remote or incidental contingencies. See
§1.171–3.
(b) Adjusted acquisition price. The adjusted acquisition price of a bond at the
beginning of the first accrual period is the
holder ’s basis as determined under
§1.171–1(e). Thereafter, the adjusted acquisition price is the holder’s basis in the
bond decreased by—
(1) The amount of bond premium previously allocable under paragraph (a)(3)
of this section; and
(2) The amount of any payment previously made on the bond other than a payment of qualified stated interest.
(c) Examples. The following examples
illustrate the rules of this section. Each
example assumes the holder uses the calendar year as its taxable year and has
elected to amortize bond premium, effective for all relevant taxable years. In addition, each example assumes a 30-day
month and 360-day year. Although, for
purposes of simplicity, the yield as stated
is rounded to two decimal places, the
computations do not reflect this rounding
convention. The examples are as follows:
Example 1. Taxable bond—(i) Facts. On February 1, 1999, A purchases for $110,000 a taxable
bond maturing on February 1, 2006, with a stated
principal amount of $100,000, payable at maturity.
The bond provides for unconditional payments of
interest of $10,000, payable on February 1 of each
year. A uses the cash receipts and disbursements
method of accounting, and A decides to use annual
accrual periods ending on February 1 of each year.
(ii) Amount of bond premium. The interest payments on the bond are qualified stated interest.

10

Therefore, the sum of all amounts payable on the
bond (other than the interest payments) is $100,000.
Under §1.171–1, the amount of bond premium is
$10,000 ($110,000–$100,000).
(iii) Bond premium allocable to the first accrual
period. Based on the remaining payment schedule
of the bond and A’s basis in the bond, A’s yield is
8.07 percent, compounded annually. The bond premium allocable to the accrual period ending on February 1, 2000, is the excess of the qualified stated interest allocable to the period ($10,000) over the
product of the adjusted acquisition price at the beginning of the period ($110,000) and A’s yield (8.07
percent, compounded annually). Therefore, the
bond premium allocable to the accrual period is
$1,118.17 ($10,000–$8,881.83).
(iv) Premium used to offset interest. Although A
receives an interest payment of $10,000 on February
1, 2000, A only includes in income $8,881.83, the
qualified stated interest allocable to the period
($10,000) offset with bond premium allocable to the
period ($1,118.17). Under §1.1016–5(b), A’s basis
in the bond is reduced by $1,118.17 on February 1,
2000.
Example 2. Alternative accrual periods—(i)
Facts. The facts are the same as in Example 1 of this
paragraph (c) except that A decides to use semiannual accrual periods ending on February 1 and August 1 of each year.
(ii) Bond premium allocable to the first accrual
period. Based on the remaining payment schedule
of the bond and A’s basis in the bond, A’s yield is
7.92 percent, compounded semiannually. The bond
premium allocable to the accrual period ending on
August 1, 1999, is the excess of the qualified stated
interest allocable to the period ($5,000) over the
product of the adjusted acquisition price at the beginning of the period ($110,000) and A’s yield,
stated appropriately taking into account the length of
the accrual period (7.92 percent/2). Therefore, the
bond premium allocable to the accrual period is
$645.29 ($5,000–$4,354.71). Although the accrual
period ends on August 1, 1999, the qualified stated
interest of $5,000 is not taken into income until February 1, 2000, the date it is received. Likewise, the
bond premium of $645.29 is not taken into account
until February 1, 2000. The adjusted acquisition
price of the bond on August 1, 1999, is $109,354.71
(the adjusted acquisition price at the beginning of
the period ($110,000) less the bond premium allocable to the period ($645.29)).
(iii) Bond premium allocable to the second accrual period. Because the interval between payments of qualified stated interest contains more than
one accrual period, the adjusted acquisition price at
the beginning of the second accrual period must be
adjusted for the accrued but unpaid qualified stated
interest. See paragraph (a)(3)(iii) of this section and
§1.1272–1(b)(4)(i)(B). Therefore, the adjusted acquisition price on August 1, 1999, is $114,354.71
($109,354.71 + $5,000). The bond premium allocable to the accrual period ending on February 1,
2000, is the excess of the qualified stated interest allocable to the period ($5,000) over the product of the
adjusted acquisition price at the beginning of the period ($114,354.71) and A’s yield, stated appropriately taking into account the length of the accrual
period (7.92 percent/2). Therefore, the bond premium allocable to the accrual period is $472.88
($5,000–$4,527.12).

1998–7 I.R.B.

(iv) Premium used to offset interest. Although A
receives an interest payment of $10,000 on February
1, 2000, A only includes in income $8,881.83, the
qualified stated interest of $10,000 ($5,000 allocable
to the accrual period ending on August 1, 1999, and
$5,000 allocable to the accrual period ending on
February 1, 2000) offset with bond premium of
$1,118.17 ($645.29 allocable to the accrual period
ending on August 1, 1999, and $472.88 allocable to
the accrual period ending on February 1, 2000). As
indicated in Example 1 of this paragraph (c), this
same amount would be taken into income at the
same time had A used annual accrual periods.
Example 3. Holder uses accrual method of accounting—(i) Facts. The facts are the same as in Example 1 of this paragraph (c) except that A uses an
accrual method of accounting. Thus, for the accrual
period ending on February 1, 2000, the qualified
stated interest allocable to the period is $10,000, and
the bond premium allocable to the period is
$1,118.17. Because the accrual period extends beyond the end of A’s taxable year, A must allocate
these amounts between the two taxable years.
(ii) Amounts allocable to the first taxable year.
The qualified stated interest allocable to the first taxable year is $9,166.67 ($10,000 3 11/12). The bond
premium allocable to the first taxable year is
$1,024.99 ($1,118.17 3 11/12).
(iii) Premium used to offset interest. For 1999, A
includes in income $8,141.68, the qualified stated
interest allocable to the period ($9,166.67) offset
with bond premium allocable to the period
($1,024.99). Under §1.1016–5(b), A’s basis in the
bond is reduced by $1,024.99 in 1999.
(iv) Amounts allocable to the next taxable year.
The remaining amounts of qualified stated interest
and bond premium allocable to the accrual period
ending on February 1, 2000, are taken into account
for the taxable year ending on December 31, 2000.
Example 4. Tax-exempt obligation—(i) Facts.
On January 15, 1999, C purchases for $120,000 a
tax-exempt obligation maturing on January 15,
2006, with a stated principal amount of $100,000,
payable at maturity. The obligation provides for unconditional payments of interest of $9,000, payable
on January 15 of each year. C uses the cash receipts
and disbursements method of accounting, and C decides to use annual accrual periods ending on January 15 of each year.
(ii) Amount of bond premium. The interest payments on the obligation are qualified stated interest.
Therefore, the sum of all amounts payable on the
obligation (other than the interest payments) is
$100,000. Under §1.171–1, the amount of bond premium is $20,000 ($120,000–$100,000).
(iii) Bond premium allocable to the first accrual
period. Based on the remaining payment schedule
of the obligation and C’s basis in the obligation, C’s
yield is 5.48 percent, compounded annually. The
bond premium allocable to the accrual period ending
on January 15, 2000, is the excess of the qualified
stated interest allocable to the period ($9,000) over
the product of the adjusted acquisition price at the
beginning of the period ($120,000) and C’s yield
(5.48 percent, compounded annually). Therefore,
the bond premium allocable to the accrual period is
$2,420.55 ($9,000–$6,579.45).
(iv) Premium used to offset interest. Although C
receives an interest payment of $9,000 on January
15, 2000, C only receives tax-exempt interest in-

1998–7 I.R.B

come of $6,579.45, the qualified stated interest allocable to the period ($9,000) offset with bond premium allocable to the period ($2,420.55). Under
§1.1016–5(b), C’s basis in the obligation is reduced
by $2,420.55 on January 15, 2000.

§1.171–3 Special rules for certain
bonds.
(a) Variable rate debt instruments. A
holder determines bond premium on a
variable rate debt instrument by reference
to the stated redemption price at maturity
of the equivalent fixed rate debt instrument constructed for the variable rate debt
instrument. The holder also allocates any
bond premium among the accrual periods
by reference to the equivalent fixed rate
debt instrument. The holder constructs
the equivalent fixed rate debt instrument,
as of the date the holder acquires the variable rate debt instrument, by using the
principles of §1.1275–5(e). See paragraph (e) Example 1 of this section.
(b) Inflation-indexed debt instruments.
A holder determines bond premium on an
inflation-indexed debt instrument by assuming that there will be no inflation or
deflation over the remaining term of the
instrument. The holder also allocates any
bond premium among the accrual periods
by assuming that there will be no inflation
or deflation over the remaining term of
the instrument. The bond premium allocable to an accrual period offsets qualified stated interest allocable to the period.
Notwithstanding §1.171–2(a)(4), if the
bond premium allocable to an accrual period exceeds the qualified stated interest
allocable to the period, the excess is
treated as a deflation adjustment under
§1.1275–7T(f)(1)(i). See §1.1275–7T for
other rules relating to inflation-indexed
debt instruments.
(c) Yield and remaining payment schedule of certain bonds subject to contingencies—(1) Applicability. This paragraph
(c) provides rules that apply in determining the yield and remaining payment
schedule of certain bonds that provide for
an alternative payment schedule (or
schedules) applicable upon the occurrence of a contingency (or contingencies).
This paragraph (c) applies, however, only
if the timing and amounts of the payments
that comprise each payment schedule are
known as of the date the holder acquires
the bond (the acquisition date) and the
bond is subject to paragraph (c)(2), (3), or
(4) of this section. A bond does not pro-

11

vide for an alternative payment schedule
merely because there is a possibility of
impairment of a payment (or payments)
by insolvency, default, or similar circumstances. See §1.1275–4 for the treatment
of a bond that provides for a contingency
that is not described in this paragraph (c).
(2) Remaining payment schedule that is
significantly more likely than not to occur.
If, based on all the facts and circumstances as of the acquisition date, a single
remaining payment schedule for a bond is
significantly more likely than not to
occur, this remaining payment schedule is
used to determine and amortize bond premium under §§1.171–1 and 1.171–2.
(3) Mandatory sinking fund provision.
Notwithstanding paragraph (c)(2) of this
section, if a bond is subject to a mandatory sinking fund provision described in
§1.1272–1(c)(3), the provision is ignored
for purposes of determining and amortizing bond premium under §§1.171–1 and
1.171–2.
(4) Treatment of certain options—(i)
Applicability. Notwithstanding paragraphs (c)(2) and (3) of this section, the
rules of this paragraph (c)(4) determine
the remaining payment schedule of a
bond that provides the holder or issuer
with an unconditional option or options,
exercisable on one or more dates during
the remaining term of the bond, to alter
the bond’s remaining payment schedule.
(ii) Operating rules. A holder determines the remaining payment schedule of
a bond by assuming that each option will
(or will not) be exercised under the following rules:
(A) Issuer options. In general, the issuer is deemed to exercise or not exercise
an option or combination of options in the
manner that minimizes the holder’s yield
on the obligation. However, the issuer of
a taxable bond is deemed to exercise or
not exercise a call option or combination
of call options in the manner that maximizes the holder’s yield on the bond.
(B) Holder options. A holder is
deemed to exercise or not exercise an option or combination of options in the manner that maximizes the holder’s yield on
the bond.
(C) Multiple options. If both the issuer
and the holder have options, the rules of
paragraphs (c)(4)(ii)(A) and (B) of this
section are applied to the options in the
order that they may be exercised. Thus,

February 17, 1998

the deemed exercise of one option may
eliminate other options that are later in
time.
(5) Subsequent adjustments—(i) In
general. Except as provided in paragraph
(c)(5)(ii) of this section, if a contingency
described in this paragraph (c) (including
the exercise of an option described in
paragraph (c)(4) of this section) actually
occurs or does not occur, contrary to the
assumption made pursuant to paragraph
(c) of this section (a change in circumstances), then solely for purposes of section 171, the bond is treated as retired and
reacquired by the holder on the date of the
change in circumstances for an amount
equal to the adjusted acquisition price of
the bond as of that date. If, however, the
change in circumstances results in a substantially contemporaneous pro-rata prepayment as defined in §1.1275–2(f)(2),
the pro-rata prepayment is treated as a
payment in retirement of a portion of the
bond. See paragraph (e) Example 2 of
this section.
(ii) Bond premium deduction on the issuer’s call of a taxable bond. If a change
in circumstances results from an issuer’s
call of a taxable bond or a partial call that
is a pro-rata prepayment, the holder may
deduct as bond premium an amount equal
to the excess, if any, of the holder’s adjusted acquisition price of the bond over
the greater of—

Example 1. Variable rate debt instrument—(i)
Facts. On March 1, 1999, E purchases for $110,000
a taxable bond maturing on March 1, 2007, with a
stated principal amount of $100,000, payable at maturity. The bond provides for unconditional payments of interest on March 1 of each year based on
the percentage appreciation of a nationally-known
commodity index. On March 1, 1999, it is reason-

Accrual period
ending

Adjusted
acquisition
price at beginning
of accrual period

3/1/00
3/1/01
3/1/02
3/1/03
3/1/04
3/1/05
3/1/06
3/1/07

$110,000.00
109,129.29
108,170.48
107,114.66
105,952.02
104,671.75
103,261.95
101,709.51

(iv) Qualified stated interest for each accrual period. Assume the bond actually pays the following
amounts of qualified stated interest:
Accrual period ending

Qualified stated interest

3/1/00
3/1/01
3/1/02
3/1/03
3/1/04
3/1/05
3/1/06
3/1/07

$2,000.00
0.00
0.00
10,000.00
8,000.00
12,000.00
15,000.00
8,500.00

February 17, 1998

(A) The amount received on redemption; and
(B) The amounts that would have been
payable under the bond (other than payments of qualified stated interest) if no
change in circumstances had occurred.
(d) Remote and incidental contingencies. For purposes of determining and
amortizing bond premium, if a bond provides for a contingency that is remote or
incidental (within the meaning of
§1.1275–2(h)), the holder takes the contingency into account under the rules for
remote and incidental contingencies in
§1.1275–2(h).
(e) Examples. The following examples
illustrate the rules of this section. Each
example assumes the holder uses the calendar year as its taxable year and has
elected to amortize bond premium, effective for all relevant taxable years. In addition, each example assumes a 30-day
month and 360-day year. Although, for
purposes of simplicity, the yield as stated
is rounded to two decimal places, the
computations do not reflect this rounding
convention. The examples are as follows:

(v) Premium used to offset interest. E’s interest
income for each accrual period is determined by offsetting the qualified stated interest allocable to the
period with the bond premium allocable to the period. For the accrual period ending on March 1,
2000, E includes in income $1,129.29, the qualified
stated interest allocable to the period ($2,000) offset
with the bond premium allocable to the period
($870.71). For the accrual period ending on March
1, 2001, the bond premium allocable to the accrual
period ($958.81) exceeds the qualified stated interest allocable to the period ($0) and, therefore, E does

12

ably expected that the bond will yield 12 percent,
compounded annually. E uses the cash receipts and
disbursements method of accounting, and E decides
to use annual accrual periods ending on March 1 of
each year. Assume that the bond is a variable rate
debt instrument under §1.1275–5.
(ii) Amount of bond premium. Because the bond
is a variable rate debt instrument, E determines and
amortizes its bond premium by reference to the
equivalent fixed rate debt instrument constructed for
the bond as of March 1, 1999. Because the bond
provides for interest at a single objective rate that is
reasonably expected to yield 12 percent, compounded annually, the equivalent fixed rate debt instrument for the bond is an eight-year bond with a
principal amount of $100,000, payable at maturity.
It provides for annual payments of interest of
$12,000. E’s basis in the equivalent fixed rate debt
instrument is $110,000. The sum of all amounts
payable on the equivalent fixed rate debt instrument
(other than payments of qualified stated interest) is
$100,000. Under §1.171–1, the amount of bond premium is $10,000 ($110,000–$100,000).
(iii) Bond premium allocable to each accrual period. E allocates bond premium to the remaining accrual periods by reference to the payment schedule
on the equivalent fixed rate debt instrument. Based
on the payment schedule of the equivalent fixed rate
debt instrument and E’s basis in the bond, E’s yield
is 10.12 percent, compounded annually. The bond
premium allocable to the accrual period ending on
March 1, 2000, is the excess of the qualified stated
interest allocable to the period for the equivalent
fixed rate debt instrument ($12,000) over the product of the adjusted acquisition price at the beginning
of the period ($110,000) and E’s yield (10.12 percent, compounded annually). Therefore, the bond
premium allocable to the accrual period is $870.71
($12,000–$11,129.29). The bond premium allocable to all the accrual periods is listed in the following schedule:

Premium allocable
to accrual period
$870.71
958.81
1,055.82
1,162.64
1,280.27
1,409.80
1,552.44
1,709.51
$10,000.00
not have interest income for this accrual period.
However, under §1.171–2(a)(4)(i)(A), E may deduct
as bond premium $958.81, the excess of the bond
premium allocable to the accrual period ($958.81)
over the qualified stated interest allocable to the accrual period ($0). For the accrual period ending on
March 1, 2002, the bond premium allocable to the
accrual period ($1,055.82) exceeds the qualified
stated interest allocable to the accrual period ($0)
and, therefore, E does not have interest income for
the accrual period. Under §1.171–2(a)(4)(i)(A), E’s
deduction for bond premium for the accrual period

1998–7 I.R.B.

is limited to $170.48, the excess of E’s total interest
inclusions on the bond in prior accrual periods
($1,129.29) over the total amount treated by E as a
bond premium deduction in prior accrual periods

Accrual
period
ending

Qualified
stated
interest

3/1/00
3/1/01
3/1/02
3/1/03
3/1/04
3/1/05
3/1/06
3/1/07

$2,000.00
0.00
0.00
10,000.00
8,000.00
12,000.00
15,000.00
8,500.00

Example 2. Partial call that results in a pro-rata
prepayment—(i) Facts. On April 1, 1999, M purchases for $110,000 N’s taxable bond maturing on
April 1, 2006, with a stated principal amount of
$100,000, payable at maturity. The bond provides
for unconditional payments of interest of $10,000,
payable on April 1 of each year. N has the option to
call all or part of the bond on April 1, 2001, at a 5
percent premium over the principal amount. M uses
the cash receipts and disbursements method of accounting.
(ii) Determination of yield and the remaining
payment schedule. M’s yield determined without regard to the call option is 8.07 percent, compounded
annually. M’s yield determined by assuming N exercises its call option is 6.89 percent, compounded
annually. Under paragraph (c)(4)(ii)(A) of this section, it is assumed N will not exercise the call option
because exercising the option would minimize M’s
yield. Thus, for purposes of determining and amortizing bond premium, the bond is assumed to be a
seven-year bond with a single principal payment at
maturity of $100,000.
(iii) Amount of bond premium. The interest payments on the bond are qualified stated interest.
Therefore, the sum of all amounts payable on the
bond (other than the interest payments) is $100,000.
Under §1.171–1, the amount of bond premium is
$10,000 ($110,000–$100,000).
(iv) Bond premium allocable to the first two accrual periods. For the accrual period ending on
April 1, 2000, M includes in income $8,881.83, the
qualified stated interest allocable to the period
($10,000) offset with bond premium allocable to the
period ($1,118.17). The adjusted acquisition price
on April 1, 2000, is $108,881.83 ($110,000–
$1,118.17). For the accrual period ending on April
1, 2001, M includes in income $8,791.54, the qualified stated interest allocable to the period ($10,000)
offset with bond premium allocable to the period
($1,208.46). The adjusted acquisition price on April
1, 2001, is $107,673.37 ($108,881.83–$1,208.46).
(v) Partial call. Assume N calls one-half of M’s
bond for $52,500 on April 1, 2001. Because it was
assumed the call would not be exercised, the call is a
change in circumstances. However, the partial call
is also a pro-rata prepayment within the meaning of
§1.1275–2(f)(2). As a result, the call is treated as a
retirement of one-half of the bond. Under paragraph

1998–7 I.R.B

($958.81). Under §1.171–2(a)(4)(i)(B), E must
carry forward the remaining $885.34 of bond premium allocable to the period ending March 1, 2002,
and treat it as bond premium allocable to the period
Premium
allocable
to accrual
period

Interest
income

$870.71
958.81
1,055.82
1,162.64
1,280.27
1,409.80
1,552.44
1,709.51
$10,000.00

$1,129.29
0.00
0.00
7,951.93
6,719.73
10,590.20
13,447.56
6,790.49

(c)(5)(ii) of this section, M may deduct $1,336.68,
the excess of its adjusted acquisition price in the retired portion of the bond ($107,673.37/2, or
$53,836.68) over the amount received on redemption ($52,500). M’s adjusted basis in the portion of
the bond that remains outstanding is $53,836.68
($107,673.37– $53,836.68).

§1.171–4 Election to amortize bond
premium on taxable bonds.
(a) Time and manner of making the
election—(1) In general. A holder makes
the election to amortize bond premium by
offsetting interest income with bond premium in the holder’s timely filed federal
income tax return for the first taxable year
to which the holder desires the election to
apply. The holder should attach to the return a statement that the holder is making
the election under this section.
(2) Coordination with OID election. If
a holder makes an election under
§1.1272–3 for a bond with bond premium, the holder is deemed to have made
the election under this section.
(b) Scope of election. The election
under this section applies to all taxable
bonds held during or after the taxable year
for which the election is made.
(c) Election to amortize made in a subsequent taxable year—(1) In general. If a
holder elects to amortize bond premium
and holds a taxable bond acquired before
the taxable year for which the election is
made, the holder may not amortize
amounts that would have been amortized
in prior taxable years had an election been
in effect for those prior years.
(2) Example. The following example
illustrates the rule of this paragraph (c):
Example—(i) Facts. On May 1, 1999, C purchases for $130,000 a taxable bond maturing on

13

ending March 1, 2003. The amount E includes in income for each accrual period is shown in the following schedule:

Premium
deduction

Premium
carryforward

$958.81
170.48

$885.34

May 1, 2006, with a stated principal amount of
$100,000, payable at maturity. The bond provides
for unconditional payments of interest of $15,000,
payable on May 1 of each year. C uses the cash receipts and disbursements method of accounting and
the calendar year as its taxable year. C has not previously elected to amortize bond premium, but does
so for 2002.
(ii) Amount to amortize. C’s basis for determining
loss on the sale or exchange of the bond is $130,000.
Thus, under §1.171–1, the amount of bond premium
is $30,000. Under §1.171–2, if a bond premium election were in effect for the prior taxable years, C would
have amortized $3,257.44 of bond premium on May
1, 2000, and $3,551.68 of bond premium on May 1,
2001, based on annual accrual periods ending on May
1. Thus, for 2002 and future years to which the election applies, C may amortize only $23,190.88
($30,000–$3,257.44–$3,551.68).

(d) Revocation of election. The election under this section may not be revoked unless approved by the Commissioner. Because a revocation of the
election is a change in accounting
method, a taxpayer must follow the rules
under §1.446–1(e)(3)(i) to request the
Commissioner’s consent to revoke the
election. A revocation of the election applies to all taxable bonds held during or
after the taxable year for which the revocation is effective. The holder may not
amortize any remaining bond premium on
bonds held at the beginning of the taxable
year for which the revocation is effective.
Therefore, no adjustment under section
481 is allowed upon the revocation of the
election because no items of income or
deduction are omitted or duplicated.
Par. 5. Section 1.171–5 is added to
read as follows:
§1.171–5 Effective date and transition
rules.
(a) Effective date—(1) In general. Sec-

February 17, 1998

tions 1.171-1 through 1.171–4 apply to
bonds acquired on or after March 2, 1998.
However, if a holder makes the election
under §1.171–4 for the taxable year containing March 2, 1998, or any subsequent
taxable year, §§1.171–1 through 1.171–4
apply to bonds held on or after the first
day of the taxable year in which the election is made.
(2) Transition rule for use of constant
yield. Notwithstanding paragraph (a)(1)
of this section, §1.171–2(a)(3) (providing
that the bond premium allocable to an accrual period is determined with reference
to a constant yield) does not apply to a
bond issued before September 28, 1985.
(b) Coordination with existing election.
A holder is deemed to have made the election under §1.171-4 for the taxable year
containing March 2, 1998, if the holder
elected to amortize bond premium under
section 171 and that election is effective
on March 2, 1998. If the holder is
deemed to have made the election under
§1.171–4 for the taxable year containing
March 2, 1998, §§1.171–1 through
1.171–4 apply to bonds acquired on or
after the first day of that taxable year. See
§1.171–4(d) for rules relating to a revocation of an election under section 171.
(c) Accounting method changes—(1)
Consent to change. A holder required to
change its method of accounting for bond
premium to comply with §§1.171–1
through 1.171–3 must secure the consent
of the Commissioner in accordance with
the requirements of §1.446–1(e). Paragraph (c)(2) of this section provides the
Commissioner’s automatic consent for certain changes. A holder making the election
under §1.171–4 does not need the Commissioner’s consent to make the election.
(2) Automatic consent. The Commissioner grants consent for a holder to
change its method of accounting for bond
premium with respect to taxable bonds to
which §§1.171–1 through 1.171–3 apply.
Because this change is made on a cut-off
basis, no items of income or deduction are
omitted or duplicated and, therefore, no
adjustment under section 481 is allowed.
The consent granted by this paragraph
(c)(2) applies provided—
(i) The holder elected to amortize bond
premium under section 171 for a taxable
year prior to the taxable year containing
March 2, 1998, and that election has not
been revoked;

February 17, 1998

(ii) The change is made for the first taxable year for which the holder must account for a bond under §§1.171–1
through 1.171–3; and
(iii) The holder attaches to its return for
the taxable year containing the change a
statement that it has changed its method
of accounting under this section.
Par. 6. Section 1.249–1 is amended by
revising paragraph (c) and the first sentence of paragraph (d)(2) to read as follows:
§1.249–1 Limitation on deduction of
bond premium on repurchase.
*

*

*

*

*

(c) Repurchase premium. For purposes
of this section, the term repurchase premium means the excess of the repurchase
price paid or incurred to repurchase the
obligation over its adjusted issue price
(within the meaning of §1.1275–1(b)) as
of the repurchase date. For the general
rules applicable to the deductibility of repurchase premium, see §1.163–7(c). This
paragraph (c) applies to convertible obligations repurchased on or after March 2,
1998.
(d) * * *
(2) * * * For a convertible obligation
repurchased on or after March 2, 1998, a
call premium specified in dollars under
the terms of the obligation is considered
to be a normal call premium on a nonconvertible obligation if the call premium applicable when the obligation is repurchased does not exceed an amount equal
to the interest (including original issue
discount) that otherwise would be deductible for the taxable year of repurchase
(determined as if the obligation were not
repurchased). * * *
*

*

*

*

*

Par. 7. Section 1.1016–5 is amended by
revising paragraph (b) to read as follows:
§1.1016–5 Miscellaneous adjustments to
basis.
*

*

*

*

*

(b) Amortizable bond premium—(1) In
general. A holder’s basis in a bond is reduced by the amount of bond premium
used to offset qualified stated interest income under §1.171–2. This reduction occurs when the holder takes the qualified

14

stated interest into account under the
holder’s regular method of accounting.
(2) Special rules for taxable bonds. A
holder’s basis in a taxable bond is reduced
by the amount of bond premium allowed
as a deduction under §1.171–3(c)(5)(ii)
(relating to the issuer’s call of a taxable
bond) or under §1.171–2(a)(4)(i)(A) (relating to excess bond premium).
(3) Special rule for tax-exempt obligations. A holder’s basis in a tax-exempt
obligation is reduced by the amount of excess bond premium that is treated as a
nondeductible loss under §1.171– 2(a)(4)(ii).
*

*

*

*

*

§1.1016–9 [Removed]
Par. 8. Section 1.1016–9 is removed.
Par. 9. Section 1.1275–1 is amended
by:
1. Redesignating paragraph (b)(2) as
paragraph (b)(3). 2. Adding a new paragraph (b)(2).
The addition reads as follows:
§1.1275–1 Definitions.
*

*

*

*

*

(b) * * *
(2) Bond issuance premium. If a debt
instrument is issued with bond issuance
premium (as defined in §1.163–13(c)), for
purposes of determining the issuer’s adjusted issue price, the adjusted issue price
determined under paragraph (b)(1) of this
section is also decreased by the amount of
bond issuance premium previously allocable under §1.163–13(d)(3).
*

*

*

*

*

PART 602—OMB CONTROL
NUMBERS UNDER THE
PAPERWORK REDUCTION ACT
Par. 10. The authority citation for part
602 continues to read as follows:
Authority: 26 U.S.C. 7805.
Par. 11. Section 602.101, paragraph (c)
is amended by:
1. Removing the following entry from
the table:
§602.101 OMB Control numbers.
*

*

*

*

*

(c) * * *

1998–7 I.R.B.

CFR part or section
where identified
and described

Current OMB
control No.

* * * * *
1.171–3 . . . . . . . . . . . . . . . . .1545–0172
*

*

*

*

*

2. Adding entries in numerical order to
the table to read as follows:

ACTION: Final regulations.
SUMMARY: This document contains
final regulations relating to deductions
available upon demolition of a building.
These final regulations reflect changes to
the law made by the Tax Reform Act of
1984 and affect owners and lessees of real
property who demolish buildings.
DATES: The regulations are effective
December 30, 1997.

§602.101 OMB Control numbers.
*

*

*

*

*

(c) * * *
CFR part or section
where identified
and described

Current OMB
control No.

* * * * *
1.163–13 . . . . . . . . . . . . . . . .1545–1491
* * * * *
1.171–4 . . . . . . . . . . . . . . . . .1545–1491
1.171–5 . . . . . . . . . . . . . . . . .1545–1491
*

*

*

*

*

Michael P. Dolan,
Deputy Commissioner of
Internal Revenue.
Approved December 15, 1997.
Donald C. Lubick,
Acting Assistant Secretary of
the Treasury.
(Filed by the Office of the Federal Register on
December 30, 1997, 8:45 a.m., and published in the
issue of the Federal Register for December 31, 1997,
62 F.R. 68173)

Section 280B.—Demolition of
Structures
26 CFR 1.280B–1: Demolition of structures.

T.D. 8745
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
Definition of Structure
AGENCY: Internal Revenue Service
(IRS), Treasury.

1998–7 I.R.B

FOR FURTHER INFORMATION CONTACT: Bernard P. Harvey, (202) 6223110 (not a toll-free number). For dates
of applicability of these regulations, see §
1.280B–1(c).
SUPPLEMENTARY INFORMATION:
Background
This document contains final regulations under section 280B of the Internal
Revenue Code. Section 280B was added
by the Tax Reform Act of 1976, Public
Law 94–455, 2124(b), 90 Stat. 1520,
1918 (Oct. 4, 1976), and significant
amendments were made to the provision
by the Economic Recovery Tax Act of
1981, Public Law 97–34, 212(d)(2)(C)
and (e)(2), 95 Stat. 172, 239 (Aug. 13,
1981) (1981 Act) and the Tax Reform Act
of 1984, Public Law 98–369, 1063, 98
Stat. 494, 1047 (July 18, 1984) (1984
Act). Transition rules were provided in
the Tax Reform Act of 1986, Public Law
99–514, 1878(h), 100 Stat. 2085, 2904
(Oct. 22, 1986) (1986 Act). As originally
enacted, section 280B required any costs
or losses incurred on account of the demolition of any certified historic structure (a
building or structure meeting certain requirements) to be capitalized into the land
upon which the demolished structure was
located. The 1981 Act modified the definition of certified historic structure for purposes of section 280B from a building or
structure meeting certain requirements to a
building (or its structural components)
meeting certain requirements. The 1984
Act substituted “any structure” for “certified historic structure.”
A notice of proposed rulemaking was
published in the Federal Register (61 F.R.
31473 [PS–39–93, 1996–2 C.B. 489]) on
June 20, 1996. The one written comment
received supports the position announced
in the notice of proposed rulemaking.

15

These final regulations define what
“structure” means for purposes of section
280B.
Explanation of Provisions
These final regulations define the term
“structure” for purposes of section 280B
as a building and its structural components as those terms are defined in §1.48–
1(e) of the Income Tax Regulations.
Thus, under section 280B, a structure will
include only a building and its structural
components and not other inherently permanent structures such as oil and gas storage tanks, blast furnaces, and coke ovens.
The final regulations rely on the legislative history underlying the 1984 and
1986 Acts, which refer repeatedly to
buildings rather than to structures generally. In addition, the legislative history of
the 1984 Act discusses the difficulty of
applying the intent test of §1.165–3 of the
regulations, which applies to the demolition of buildings, and indicates that the
newly added language is meant to eliminate this difficulty.
Special Analyses
It has been determined that this Treasury decision is not a significant regulatory action as defined in EO 12866.
Therefore, a regulatory assessment is not
required. It also has been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not
apply to these regulations and, because
these regulations do not impose on small
entities a collection of information requirement, the Regulatory Flexibility Act
(5 U.S.C. chapter 6) does not apply.
Therefore, a Regulatory Flexibility
Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue
Code, the notice of proposed rulemaking
preceding these regulations was submitted to the Chief Counsel for Advocacy of
the Small Business Administration for
comment on its impact on small business.
Drafting Information
The principal author of these regulations is Bernard P. Harvey, Office of Assistant Chief Counsel (Passthroughs and
Special Industries). However, other personnel from the IRS and Treasury Department participated in their development.
*

*

*

*

*

February 17, 1998

Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 1 is amended
as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.280B–1 is added to
read as follows:
§1.280B–1 Demolition of structures.
(a) In general. Section 280B provides
that, in the case of the demolition of any
structure, no deduction otherwise allowable under chapter 1 of subtitle A shall be
allowed to the owner or lessee of such
structure for any amount expended for the
demolition or any loss sustained on account of the demolition, and that the expenditure or loss shall be treated as properly chargeable to the capital account with
respect to the land on which the demolished structure was located.
(b) Definition of structure. For purposes of section 280B, the term structure
means a building, as defined in §1.48–
1(e)(1), including the structural components of that building, as defined in
§1.48–1(e)(2).
(c) Effective date. This section is effective for demolitions commencing on or
after December 30, 1997.

tain tax-exempt organizations that will be treated as
satisfying the requirements of § 6033(e)(3). Those
organizations will not be subject to the reporting and
notice requirements of § 6033(e)(1) or the tax imposed by § 6033(e)(2). Procedures for other exempt
organizations to establish that they satisfy the requirements of § 6033(e)(3) are also provided. Rev.
Proc. 95–35, 1995–2 C.B. 391, and Rev. Proc.
95–35A, 1995–2 C.B. 392, are superseded. See Rev.
Proc. 98–19, page 30.

Section 1202.—50 Percent
Exclusion for Gain From Certain
Small Business Stock
26 CFR 1.1202–2: Qualified small business stock;
effect of redemptions.

T.D. 8749
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
Qualified Small Business Stock
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.

Michael P. Dolan,
Deputy Commissioner of
Internal Revenue.

SUMMARY: This document contains
final regulations relating to the 50-percent
exclusion for gain from certain small
business stock. The final regulations
reflect changes to the law made by the
Omnibus Budget Reconciliation Act of
1993 and provide guidance to the issuers
and owners of the stock of certain small
businesses.

Donald C. Lubick,
Acting Assistant Secretary of
the Treasury.

DATES: This regulation is effective December 31, 1997. For dates of applicability of these regulations, see §1.1202–2(e).

(Filed by the Office of the Federal Register on
December 29, 1997, 8:45 a.m., and published in the
issue of the Federal Register for December 30, 1997,
62 F.R. 67725)

FOR FURTHER INFORMATION CONTACT: Catherine A. Prohofsky of the Office of the Assistant Chief Counsel
(Income Tax and Accounting) at 202-6224930 (not a toll-free call).

Section 501.—Exemption From
Tax on Corporations, Certain
Trusts, Etc.
This revenue procedure provides guidance to organizations exempt from taxation under § 501(a) of
the Internal Revenue Code of 1986 on the application of amendments made to §§ 162(e) and 6033(e)
by § 13222 of the Omnibus Budget Reconciliation
Act of 1993. The revenue procedure identifies cer-

February 17, 1998

SUPPLEMENTARY INFORMATION:
Background
Section 1202 of the Internal Revenue
Code allows a taxpayer (other than a corporation) to exclude 50 percent of certain
gain from the sale or exchange of qualified small business stock held for more

16

than 5 years. This document contains
amendments to the Income Tax Regulations (26 CFR part 1) that provide guidance relating to the effect of redemptions
on the availability of this exclusion.
On June 6, 1996, the Federal Register
published a notice of proposed rulemaking (IA–26–94), 61 F.R. 28821, relating
to the effect of certain redemptions on the
50-percent exclusion of gain from the sale
or exchange of qualified small business
stock under section 1202. The proposed
regulations provide that these redemptions are disregarded in determining
whether the anti-churning rules of section
1202(c) are violated.
Four comments responding to this notice were received. A public hearing was
held on October 3, 1996. After consideration of the comments, the proposed regulations under section 1202 are adopted as
modified by this Treasury decision.
Summary of Comments and
Modifications
The notice of proposed rulemaking requested comments on how to determine
when an independent contractor has terminated services. One commentator suggested that the determination of whether
services of an independent contractor
were terminated should be based on all
the facts and circumstances, with termination conclusively presumed if no further
services were provided for six months.
The IRS and Treasury Department have
not adopted this suggestion, but are continuing to study this issue and request additional comments.
Commentators suggested an additional
exception for all redemptions occurring in
the ordinary course of business or for legitimate business reasons. The final regulations do not incorporate this suggestion.
The exceptions in the final regulations relate to redemptions that are incident to
certain events affecting a shareholder.
Because of the extraordinary nature of
these events and the fact that they are generally not within the control of the issuing
corporation, the exceptions are unlikely to
lead to avoidance of the requirement that
qualified small business stock be purchased at original issue. The IRS and
Treasury are concerned, however, that a
much broader exception for redemptions
that arise out of the ordinary business
needs and purposes of the issuing corpo-

1998–7 I.R.B.

ration, and are not incident to extraordinary events affecting its shareholders,
would be much more likely to undermine
the original issue requirement.
Two commentators requested that the
final regulations be effective for stock
purchases by an issuing corporation at
any time after August 10, 1993. The effective date has been modified in response to this suggestion. The final regulations will apply to stock issued after
August 10, 1993. Thus, regardless of the
date on which a redemption occurs (or on
which the redeemed stock was issued) the
redemption is treated as provided in the
final regulations for purposes of determining whether stock issued after August
10, 1993, is qualified small business
stock.
The Chief Counsel for Advocacy of the
Small Business Administration recommended the inclusion of an exception for
redemptions occurring in connection with
the divorce of a shareholder. This suggestion has been adopted. The final regulations provide that redemptions of stock
occurring incident to the divorce of a
shareholder are disregarded in determining whether redemptions exceed de minimis amounts.
The Chief Counsel for Advocacy also
requested that the IRS and Treasury Department analyze the current use of section 1202. No exclusion under section
1202 can be claimed until 1998 because
stock must be issued after August 10,
1993, to be qualified small business stock,
and must be held for more than 5 years to
qualify for the exclusion. Thus, the available tax return data do not provide the information necessary to analyze the current use of section 1202.
Minor clarifying changes in the regulatory language have also been made.
Special Analyses
It has been determined that this Treasury Decision is not a significant regulatory action as defined in EO 12866.
Therefore, a regulatory assessment is not
required. It also has been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C chapter 5) does not
apply to these regulations, and because
these regulations do not impose a collection of information on small entities, the
Regulatory Flexibility Act (5 U.S.C.
chapter 6) does not apply. Pursuant to

1998–7 I.R.B

section 7805(f) of the Internal Revenue
Code, the notice of proposed rulemaking
preceding these final regulations was submitted to the Chief Counsel for Advocacy
of the Small Business Administration for
comment on its impact on small business.
Drafting Information
The principal author of these regulations is Catherine A. Prohofsky, Office of
the Assistant Chief Counsel (Income Tax
and Accounting). However, other personnel from the IRS and Treasury Department participated in their development.
*

*

*

*

*

Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 1 is amended
as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 is amended by adding an entry in
numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.1202–2 is also issued under
26 U.S.C. 1202(k). * * *
Par. 2. Sections 1.1202–0 and 1.1202–
2 are added to read as follows:
§1.1202–0 Table of contents.
This section lists the major captions
that appear in the regulations under
§1.1202–2.
§1.1202–2 Qualified small business
stock; effect of redemptions.
(a) Redemptions from taxpayer or related person.
(1) In general.
(2) De minimis amount.
(b) Significant redemptions.
(1) In general.
(2) De minimis amount.
(c) Transfers by shareholders in connection with the performance of
services not treated as purchases.
(d) Exceptions for termination of services, death, disability or mental
incompetency, or divorce.
(1) Termination of services.
(2) Death.
(3) Disability or mental incompetency.
(4) Divorce.
(e) Effective date.

17

§1.1202–2 Qualified small business
stock; effect of redemptions.
(a) Redemptions from taxpayer or related person—(1) In general. Stock acquired by a taxpayer is not qualified small
business stock if, in one or more purchases during the 4-year period beginning
on the date 2 years before the issuance of
the stock, the issuing corporation purchases (directly or indirectly) more than a
de minimis amount of its stock from the
taxpayer or from a person related (within
the meaning of section 267(b) or 707(b))
to the taxpayer.
(2) De minimis amount. For purposes
of this paragraph (a), stock acquired from
the taxpayer or a related person exceeds a
de minimis amount only if the aggregate
amount paid for the stock exceeds $10,000
and more than 2 percent of the stock held
by the taxpayer and related persons is acquired. The following rules apply for purposes of determining whether the 2-percent limit is exceeded. The percentage of
stock acquired in any single purchase is
determined by dividing the stock’s value
(as of the time of purchase) by the value
(as of the time of purchase) of all stock
held (directly or indirectly) by the taxpayer and related persons immediately before the purchase. The percentage of
stock acquired in multiple purchases is the
sum of the percentages determined for
each separate purchase.
(b) Significant redemptions—(1) In
general. Stock is not qualified small
business stock if, in one or more purchases during the 2-year period beginning
on the date 1 year before the issuance of
the stock, the issuing corporation purchases more than a de minimis amount of
its stock and the purchased stock has an
aggregate value (as of the time of the respective purchases) exceeding 5 percent
of the aggregate value of all of the issuing
corporation’s stock as of the beginning of
such 2-year period.
(2) De minimis amount. For purposes
of this paragraph (b), stock exceeds a de
minimis amount only if the aggregate
amount paid for the stock exceeds
$10,000 and more than 2 percent of all
outstanding stock is purchased. The following rules apply for purposes of determining whether the 2-percent limit is exceeded. The percentage of the stock
acquired in any single purchase is determined by dividing the stock’s value (as of

February 17, 1998

the time of purchase) by the value (as of
the time of purchase) of all stock outstanding immediately before the purchase. The
percentage of stock acquired in multiple
purchases is the sum of the percentages
determined for each separate purchase.
(c) Transfers by shareholders in connection with the performance of services
not treated as purchases. A transfer of
stock by a shareholder to an employee or
independent contractor (or to a beneficiary of an employee or independent contractor) is not treated as a purchase of the
stock by the issuing corporation for purposes of this section even if the stock is
treated as having first been transferred to
the corporation under §1.83–6(d)(1) (relating to transfers by shareholders to employees or independent contractors).
(d) Exceptions for termination of services, death, disability or mental incompetency, or divorce. A stock purchase is
disregarded if the stock is acquired in the
following circumstances:
(1) Termination of services—(i) Employees and directors. The stock was acquired by the seller in connection with the
performance of services as an employee
or director and the stock is purchased
from the seller incident to the seller’s retirement or other bona fide termination of
such services;
(ii) Independent contractors. [Reserved];
(2) Death. Prior to a decedent’s death,
the stock (or an option to acquire the
stock) was held by the decedent or the
decedent’s spouse (or by both), by the
decedent and joint tenant, or by a trust revocable by the decedent or the decedent’s
spouse (or by both), and—
(i) The stock is purchased from the
decedent’s estate, beneficiary (whether by
bequest or lifetime gift), heir, surviving
joint tenant, or surviving spouse, or from
a trust established by the decedent or
decedent’s spouse; and
(ii) The stock is purchased within 3
years and 9 months from the date of the
decedent’s death;
(3) Disability or mental incompetency.
The stock is purchased incident to the disability or mental incompetency of the
selling shareholder; or
(4) Divorce. The stock is purchased incident to the divorce (within the meaning
of section 1041(c)) of the selling shareholder.

February 17, 1998

(e) Effective date. This section applies
to stock issued after August 10, 1993.
Michael P. Dolan,
Deputy Commissioner of
Internal Revenue.
Approved December 22, 1997.
Donald C. Lubick,
Acting Assistant Secretary of
the Treasury.
(Filed by the Office of the Federal Register on
December 30, 1997, 8:45 a.m., and published in the
issue of the Federal Register for December 31, 1997,
62 F.R. 68165)

Section 1396.—Empowerment
Zone Employment Credit
26 CFR 1.1396–1: Qualified zone employees.

T.D. 8747
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
Empowerment Zone
Employment Credit
AGENCY: Internal Revenue Service
(IRS), Treasury
ACTION: Final regulations.
SUMMARY: This document contains
final regulations relating to the period employers may use in computing the empowerment zone employment credit
under section 1396 of the Internal Revenue Code. The regulations reflect and
implement certain changes made by the
Omnibus Budget Reconciliation Act of
1993 (OBRA ’93). They affect employers
of employees who live and work in an
empowerment zone designated under the
statute. The regulations provide employers with the guidance necessary to claim
the credit.
DATES: These regulations are effective
December 30, 1997. For dates of applicability, see § 1.1396–1(c) of these regulations.
FOR FURTHER INFORMATION CONTACT: Robert G. Wheeler, (202) 6226060 (not a toll-free number).

18

SUPPLEMENTARY INFORMATION:
Background
On December 16, 1996, a notice of proposed rulemaking [REG–209834–96]
containing proposed regulations relating
to the period employers may use in computing the empowerment zone employment credit under section 1396 of the Internal Revenue Code was published in the
Federal Register (61 F.R. 66000).
No written comments responding to
this notice were received. No one requested an opportunity to speak at a public hearing. Therefore, no public hearing
was held. The regulations proposed by
REG–209834–96 are adopted with minor
clarifications by this Treasury decision.
Explanation of Provisions
This document contains amendments to
the Income Tax Regulations (26 CFR part
1) relating to the empowerment zone employment credit under section 1396. Section 1396 was added to the Internal Revenue Code by the Omnibus Budget
Reconciliation Act of 1993 (OBRA’93).
Section 1397D of the Code authorizes the
Secretary of the Treasury to prescribe regulations that may be necessary or appropriate to carry out the purposes of section
1396.
Section 1396 provides employers with
a credit for certain wages (qualified zone
wages) paid or incurred by an employer
for services performed by a qualifed zone
employee. The amount of the empowerment zone employment credit under section 1396 is equal to a specified percentage of the qualified zone wages paid or
incurred by the employer during the calendar year that ends with or within the
taxable year of the employer. Questions
have arisen about the definition of a
“qualified zone employee” in section
1396(d). In particular, questions have
been raised about the appropriate period
under section 1396(d)(1)(A) during which
substantially all of the services performed
by an employee for his or her employer
must be performed within an empowerment zone in a trade or business of the
employer.
Under the regulations, an employer
may use either each pay period of the calendar year or the entire calendar year as
the relevant period in determining

1998–7 I.R.B.

whether a particular employee performed
substantially all of his or her services
within an empowerment zone (the “location-of-services” requirement). For each
taxable year the employer must use the
same method for all its employees, but the
employer may change methods from one
taxable year to the next. The description of
the pay period method has been revised
slightly to clarify that the relevant pay periods are those for the calendar year with respect to which the credit is being claimed
(i.e., the calendar year ending with or
within the employer’s taxable year).
Special Analyses
It has been determined that this Treasury Decision is not a significant regulatory action as defined in EO 12866.
Therefore, a regulatory assessment is not
required. It also has been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not
apply to these regulations, and because
the regulation does not impose a collection of information on small entities, the
Regulatory Flexibility Act (5 U.S.C.
chapter 6) does not apply. Pursuant to
section 7805(f) of the Internal Revenue
Code, the notice of proposed rulemaking
preceding these regulations was submitted to the Chief Counsel for Advocacy of
the Small Business Administration for
comment on its impact on small business.
Drafting Information
The principal author of these regulations is Robert G. Wheeler, Office of Associate Chief Counsel, Employee Benefits and Exempt Organizations. However,
other personnel from the IRS and Treasury Department participated in their development.
*

*

*

*

*

Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 1 is amended
as follows:
PART 1 — INCOME TAXES
Paragraph 1. The authority citation for
part 1 is amended by adding an entry in
numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.1396–1 also issued under 26
U.S.C. 1397D.

1998–7 I.R.B

Par. 2. A new undesignated center
heading and §1.1396-1 are added to read
as follows:
Empowerment Zone Employment Credit
§1.1396–1 Qualified zone employees.
(a) In general. A qualified zone employee of an employer is an employee
who satisfies the location-of-services requirement and the abode requirement
with respect to the same empowerment
zone and is not otherwise excluded by
section 1396(d).
(1) Location-of-services requirement.
The location-of- services requirement is
satisfied if substantially all of the services
performed by the employee for the employer are performed in the empowerment
zone in a trade or business of the employer.
(2) Abode requirement. The abode requirement is satisfied if the employee’s
principal place of abode while performing
those services is in the empowerment
zone.
(b) Period for applying location-of-services requirement. In applying the location-of-services requirement, an employer
may use either the pay period method described in paragraph (b)(1) of this section
or the calendar year method described in
paragraph (b)(2) of this section. For each
taxable year of an employer, the employer
must either use the pay period method
with respect to all of its employees or use
the calendar year method with respect to
all of its employees. The employer may
change the method applied to all of its employees from one taxable year to the next.
(1) Pay period method—(i) Relevant
period. Under the pay period method, the
relevant period for applying the locationof-services requirement is each pay period in which an employee provides services to the employer during the calendar
year with respect to which the credit is
being claimed (i.e., the calendar year that
ends with or within the relevant taxable
year). If an employer has one pay period
for certain employees and a different pay
period for other employees (e.g., a weekly
pay period for hourly wage employees
and a bi-weekly pay period for salaried
employees), the pay period actually applicable to a particular employee is the
relevant pay period for that employee
under this method.

19

(ii) Application of method. Under this
method, an employee does not satisfy the
location-of-services requirement during a
pay period unless substantially all of the
services performed by the employee for
the employer during that pay period are
performed within the empowerment zone
in a trade or business of the employer.
(2) Calendar year method—(i) Relevant
period. Under the calendar year method,
the relevant period for an employee is the
entire calendar year with respect to which
the credit is being claimed. However, for
any employee who is employed by the employer for less than the entire calendar
year, the relevant period is the portion of
that calendar year during which the employee is employed by the employer.
(ii) Application of method. Under this
method, an employee does not satisfy the
location-of-services requirement during
any part of a calendar year unless substantially all of the services performed by the
employee for the employer during that
calendar year (or, if the employee is employed by the employer for less than the
entire calendar year, the portion of that
calendar year during which the employee
is employed by the employer) are performed within the empowerment zone in
a trade or business of the employer.
(3) Examples. This paragraph (b) may
be illustrated by the following examples.
In each example, the following assumptions apply. The employees satisfy the
abode requirement at all relevant times
and all services performed by the employees for their employer are performed in a
trade or business of the employer. The
employees are not precluded from being
qualified zone employees by section
1396(d)(2) (certain employees ineligible).
No portion of the employees’ wages is
precluded from being qualified zone
wages by section 1396(c)(2) (only first
$15,000 of wages taken into account) or
section 1396(c)(3) (coordination with targeted jobs credit and work opportunity
credit). The examples are as follows:
Example 1. (i) Employer X has a weekly pay period for all its employees. Employee A works for X
throughout 1997. During each of the first 20 weekly
pay periods in 1997, substantially all of A’s work for
X is performed within the empowerment zone in
which A resides. A also works in the zone at various
times during the rest of the year, but there is no other
pay period in which substantially all of A’s work for
X is performed within the empowerment zone. Employer X uses the pay period method.

February 17, 1998

(ii) For each of the first 20 pay periods of 1997, A
is a qualified zone employee, all of A’s wages from
X are qualified zone wages, and X may claim the
empowerment zone employment credit with respect
to those wages. X cannot claim the credit with respect to any of A’s wages for the rest of 1997.
Example 2. (i) Employer Y has a weekly pay period for its factory workers and a bi-weekly pay period for its office workers. Employee B works for Y
in various factories and Employee C works for Y in
various offices. Employer Y uses the pay period
method.
(ii) Y must use B’s weekly pay periods to determine the periods (if any) in which B is a qualified
zone employee. Y may claim the empowerment
zone employment credit with respect to B’s wages
only for the weekly pay periods for which B is a
qualified zone employee, because those are B’s only
wages that are qualified zone wages. Y must use C’s
bi-weekly pay periods to determine the periods (if
any) in which C is a qualified zone employee. Y
may claim the credit with respect to C’s wages only
for the bi-weekly pay periods for which C is a qualified zone employee, because those are C’s only
wages that are qualified zone wages.
Example 3. (i) Employees D and E work for Employer Z throughout 1997. Although some of D’s
work for Z in 1997 is performed outside the empowerment zone in which D resides, substantially all of
it is performed within that empowerment zone. E’s
work for Z is performed within the empowerment
zone in which E resides for several weeks of 1997
but outside the zone for the rest of the year so that,
viewed on an annual basis, E’s work is not substantially all performed within the empowerment zone.
Employer Z uses the calendar year method.
(ii) D is a qualified zone employee for the entire
year, all of D’s 1997 wages from Z are qualified
zone wages, and Z may claim the empowerment
zone employment credit with respect to all of those
wages, including the portion attributable to work
outside the zone. Under the calendar year method, E
is not a qualified zone employee for any part of
1997, none of E’s 1997 wages are qualified zone
wages, and Z cannot claim any empowerment zone
employment credit with respect to E’s wages for
1997. Z cannot use the calendar year method for D
and the pay period method for E because Z must use
the same method for all employees. For 1998, however, Z can switch to the pay period method for E if
Z also switches to the pay period method for D and
all of Z’s other employees.

(c) Effective date. This section applies
with respect to wages paid or incurred on
or after December 21, 1994.
Michael P. Dolan,
Deputy Commissioner of
Internal Revenue.
Donald C. Lubick,
Acting Assistant Secretary of
the Treasury.
(Filed by the Office of the Federal Register on
December 29, 1997, 8:45 a.m., and published in the
issue of the Federal Register for December 30, 1997,
62 F.R. 67726)

February 17, 1998

Section 2044.—Certain
Property for Which Marital
Deduction was Previously
Allowed
26 CFR 20.2044–1: Certain property for which
marital deduction was previously allowed.
What are the gift tax consequences to the surviving spouse of the acquisition by the surviving spouse
of the remainder interest in a trust subject to a qualified terminable interest property (QTIP) election
under § 2056(b)(7) of the Internal Revenue Code?
See Rev. Rul. 98–8, page 24.

Section 2056.—Bequests, Etc.,
to Surviving Spouse
26 CFR 20.2056(b)(7): Election with respect to life
estate for surviving spouse.
What are the gift tax consequences to the surviving spouse of the acquisition by the surviving spouse
of the remainder interest in a trust subject to a qualified terminable interest property (QTIP) election
under § 2056(b)(7) of the Internal Revenue Code?
See Rev. Rul. 98–8, page 24.

Section 2511.—Transfers in
General
26 CFR 25.251–1: Transfers in general.
If a surviving spouse acquires the remainder interest in a trust subject to a QTIP election under
§ 2056(b)(7) in connection with the transfer by the
surviving spouse of property or cash to the holder of
the remainder interest, does the surviving spouse
make a gift under § 2511 of the Internal Revenue
Code? See Rev. Rul. 98–8, page 24.

Section 2512.—Valuation of
Gifts
Section 25.2512–8: Transfers for insufficient
consideration.
If a surviving spouse acquires the remainder interest in a trust subject to a QTIP election under
§ 2056(b)(7) in connection with the transfer by the
surviving spouse of property or cash to the holder of
the remainder interest, what is the value of the gift
under § 2512 of the Internal Revenue Code? See
Rev. Rul. 98–8, page 24.

Section 2518.—Disclaimers
26 CFR 25.2518–2: Requirements for a qualified
disclaimer.

T.D. 8744

20

DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 20 and 25
Disclaimer of Interests and
Powers
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final Regulations.
SUMMARY: This document contains
final regulations relating to the treatment
of disclaimers for estate and gift tax purposes. The regulations clarify certain provisions governing the disclaimer of property interests and powers and, in addition,
conform the regulations to court decisions
holding the current regulation invalid
with respect to the disclaimer of joint
property interests. The final regulations
will affect persons who disclaim property
interests, powers, or interests in jointly
owned property.
DATES: Effective date: The final regulations are effective December 31, 1997.
Applicability dates: The amendments
to §§25.2518–l(a) and 25.2518–2(c)(3)
(substituting the statutory language in
section 2518(b)(2)(A) “transfer creating
the interest,” for “taxable transfer”) and
conforming changes to §§20.2041–3(d)(6)(i), 20.2046–1, 20.2056(d)–2 (a) and
(b), 25.2511–l(c)(1), 25.2514–3(c)(5), are
applicable for transfers creating the interest or power to be disclaimed made on or
after December 31, 1997. The amendments to §25.2518–2(c)(4) (relating to the
disclaimer of joint property and bank accounts) are applicable for disclaimers
made on or after December 31, 1997.
FOR FURTHER INFORMATION CONTACT: James F. Hogan (202) 622-3090
(not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
On August 21, 1996, the IRS published
in the Federal Register (61 F.R. 43197) a
notice of proposed rulemaking (REG–
208216–91) amending the regulations
under section 2518. The IRS received
comments on the proposed regulations;
however, no request for a public hearing
was received so no public hearing was

1998–7 I.R.B.

held. This document adopts final regulations with respect to this notice of proposed rulemaking.
The proposed regulations substituted the
statutory language of section 2518(b)(2)(A), “transfer creating the interest,” for
“taxable transfer” as the reference point for
determining when the 9-month time period
for making the disclaimer commences.
This change clarifies that the starting point
for the 9-month period is not dependent on
the actual imposition of a transfer tax at the
time that the interest to be disclaimed is
created. Comments with respect to the
clarification in the proposed regulation
supported the change.
Under the proposed regulations, the
one-half survivorship interest in jointlyheld property that was unilaterally severable could be disclaimed within 9 months
of the date of death of the first joint tenant
to die. The proposed regulations did not
extend the same treatment to joint interests
that are not unilaterally severable (e.g.,
tenancies by the entirety), but the preamble invited comments on this subject.
The comments received unanimously
suggested that a surviving joint tenant
should be allowed to disclaim, within 9
months of the date of death of the first
joint tenant to die, his or her survivorship
interest in a tenancy, whether or not that
tenancy is unilaterally severable. The
comment

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Airs%3A7c5ba806cec66000. Public record. Not legal advice.