Title 26 — Internal Revenue CodeRelease 119-73
§1277 Deferral of interest deduction allocable to accrued market discount
Title 26 › Subtitle Subtitle A— - Income Taxes › Chapter CHAPTER 1— - NORMAL TAXES AND SURTAXES › Subchapter Subchapter P— - Capital Gains and Losses › Part PART V— - SPECIAL RULES FOR BONDS AND OTHER DEBT INSTRUMENTS › Subpart Subpart B— - Market Discount on Bonds › § 1277
Summary
You can only deduct interest you pay to buy or hold a bond with market discount if that interest is more than the part of the market discount that applies to the days you owned the bond (use the rules in section 1276(b) to figure that part). If you have net interest income for a year and you make the election allowed by the law, the interest you could not deduct is figured as of the end of the prior year and does not include amounts already counted. The interest you couldn’t deduct becomes deductible when you sell or dispose of the bond. If the transfer is a nonrecognition deal, you can deduct only up to the gain you recognize, and any leftover disallowed interest follows the property or the transferee under section 1276(c). Net direct interest expense: the extra interest you paid in a year on debt used to buy or hold the bond, after subtracting interest from the bond. Net interest income: the excess of the amount figured under subsection (c)(2) over the amount under subsection (c)(1). Disallowed interest expense: the total interest amount not allowed under the main rule.
Full Legal Text
Title 26, §1277
Internal Revenue Code — Source: USLM XML via OLRC
(a)Except as otherwise provided in this section, the net direct interest expense with respect to any market discount bond shall be allowed as a deduction for the taxable year only to the extent that such expense exceeds the portion of the market discount allocable to the days during the taxable year on which such bond was held by the taxpayer (as determined under the rules of section 1276(b)).
(b)(1)(A)If—
(i)there is net interest income for any taxable year with respect to any market discount bond, and
(ii)the taxpayer makes an election under this subparagraph with respect to such bond,
(B)For purposes of subparagraph (A), the amount of the disallowed interest expense—
(i)shall be determined as of the close of the preceding taxable year, and
(ii)shall not include any amount previously taken into account under subparagraph (A).
(C)For purposes of this paragraph, the term “net interest income” means the excess of the amount determined under paragraph (2) of subsection (c) over the amount determined under paragraph (1) of subsection (c).
(2)(A)Except as otherwise provided in this paragraph, the amount of the disallowed interest expense with respect to any market discount bond shall be treated as interest paid or accrued by the taxpayer in the taxable year in which such bond is disposed of.
(B)If any market discount bond is disposed of in a nonrecognition transaction—
(i)the disallowed interest expense with respect to such bond shall be treated as interest paid or accrued in the year of disposition only to the extent of the amount of gain recognized on such disposition, and
(ii)the disallowed interest expense with respect to such property (to the extent not so treated) shall be treated as disallowed interest expense—
(I)in the case of a transaction described in section 1276(c)(1), of the transferee with respect to the transferred basis property, or
(II)in the case of a transaction described in section 1276(c)(2), with respect to the exchanged basis property.
(C)For purposes of this paragraph, the amount of the disallowed interest expense shall not include any amount previously taken into account under paragraph (1).
(3)For purposes of this subsection, the term “disallowed interest expense” means the aggregate amount disallowed under subsection (a) with respect to the market discount bond.
(c)For purposes of this section, the term “net direct interest expense” means, with respect to any market discount bond, the excess (if any) of—
(1)the amount of interest paid or accrued during the taxable year on indebtedness which is incurred or continued to purchase or carry such bond, over
(2)the aggregate amount of interest (including original issue discount) includible in gross income for the taxable year with respect to such bond.
Legislative History
Notes & Related Subsidiaries
Editorial Notes
Amendments
1996—Subsec. (c). Pub. L. 104–188 struck out “or to which section 593 applies” after “585(a)(2))” in closing provisions. 1993—Subsec. (d). Pub. L. 103–66 struck out heading and text of subsec. (d). Text read as follows: “In the case of a market discount bond issued on or before
July 18, 1984, any gain recognized by the taxpayer on any disposition of such bond shall be treated as ordinary income to the extent the amount of such gain does not exceed the amount allowable with respect to such bond under subsection (b)(2) for the taxable year in which such bond is disposed of.” 1988—Subsec. (c). Pub. L. 100–647 inserted a closing parenthesis after “section 585(a)(2)”. 1986—Subsec. (b)(1)(C). Pub. L. 99–514, § 1899A(29), substituted “this paragraph” for “this paragaph”. Subsec. (b)(2)(C). Pub. L. 99–514, § 1899A(30), substituted “paragraph (1)” for “paragraph 1” in heading. Subsec. (c). Pub. L. 99–514, § 901(d)(4)(F), substituted “which is a bank (as defined in section 585(a)(2) or to which section 593 applies” for “to which section 585 or 593 applies”. Pub. L. 99–514, § 902(e)(2), substituted “section 265(a)(5)” for “section 265(5)”. Subsec. (d). Pub. L. 99–514, § 1899A(31), substituted “
July 18, 1984” for “the date of the enactment of this section”.
Statutory Notes and Related Subsidiaries
Effective Date
of 1996 AmendmentAmendment by Pub. L. 104–188 applicable to taxable years beginning after Dec. 31, 1995, see section 1616(c) of Pub. L. 104–188, set out as a note under section 593 of this title.
Effective Date
of 1993 AmendmentAmendment by Pub. L. 103–66 applicable to obligations purchased (within the meaning of section 1272(d)(1) [now 1272(c)(1)] of this title) after Apr. 30, 1993, see section 13206(b)(3) of Pub. L. 103–66, set out as a note under section 1276 of this title.
Effective Date
of 1988 AmendmentAmendment by Pub. L. 100–647 effective, except as otherwise provided, as if included in the provision of the Tax Reform Act of 1986, Pub. L. 99–514, to which such amendment relates, see section 1019(a) of Pub. L. 100–647, set out as a note under section 1 of this title.
Effective Date
of 1986 AmendmentAmendment by section 901(d)(4)(F) of Pub. L. 99–514 applicable to taxable years beginning after Dec. 31, 1986, see section 901(e) of Pub. L. 99–514, set out as a note under section 166 of this title. Amendment by section 902(e)(2) of Pub. L. 99–514 applicable to taxable years ending after Dec. 31, 1986, with certain exceptions and qualifications, see section 902(f) of Pub. L. 99–514, set out as a note under section 265 of this title.
Effective Date
Section applicable to taxable years ending after
July 18, 1984, and applicable to obligations acquired after
July 18, 1984, in taxable years ending after such date, see section 44 of Pub. L. 98–369, set out as a note under section 1271 of this title. Plan
Amendments
Not Required Until January 1, 1989For provisions directing that if any
Amendments
made by subtitle A or subtitle C of title XI [§§ 1101–1147 and 1171–1177] or title XVIII [§§ 1800–1899A] of Pub. L. 99–514 require an amendment to any plan, such plan amendment shall not be required to be made before the first plan year beginning on or after Jan. 1, 1989, see section 1140 of Pub. L. 99–514, as amended, set out as a note under section 401 of this title.
Reference
Citations & Metadata
Citation
26 U.S.C. § 1277
Title 26 — Internal Revenue Code
Last Updated
Apr 6, 2026
Release point: 119-73