Title 26 — Internal Revenue CodeRelease 119-73
§1278 Definitions and special rules
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 › § 1278
Summary
Explains when a bond’s price difference counts as a market discount and how to measure and report it. A market discount bond is one bought for less than its redemption at maturity, but it does not include obligations with a fixed maturity of 1 year or less, United States savings bonds, installment obligations covered by section 453B, certain tax-exempt obligations for section 1277, and generally bonds bought at original issue (with limited exceptions for some reorganizations or when the buyer’s basis is set by section 1012 and is less than the issue price). Market discount equals the bond’s stated redemption price at maturity minus the buyer’s basis right after purchase. For bonds with original issue discount, use the revised issue price instead. If the discount is less than 1/4 of 1 percent of the stated redemption price times the number of full years left after purchase, treat the market discount as zero. “Bond” means any evidence of debt. “Revised issue price” equals the issue price plus original issue discount already included in earlier holders’ income. A taxpayer may elect to opt out of sections 1276 and 1277 and instead include market discount in income as it accrues. That election must apply to all market discount bonds bought on or after the 1st day of the 1st taxable year it covers and stays in effect for that year and later years unless the Secretary allows revocation. Amounts included under the election increase the bond’s basis. The Secretary will create regulations, including rules for bonds whose principal may be paid in more than one payment.
Full Legal Text
Title 26, §1278
Internal Revenue Code — Source: USLM XML via OLRC
(a)For purposes of this part—
(1)(A)Except as provided in subparagraph (B), the term “market discount bond” means any bond having market discount.
(B)The term “market discount bond” shall not include—
(i)Any obligation with a fixed maturity date not exceeding 1 year from the date of issue.
(ii)Any United States savings bond.
(iii)Any installment obligation to which section 453B applies.
(C)For purposes of section 1277, the term “market discount bond” shall not include any tax-exempt obligation (as defined in section 1275(a)(3)).
(D)(i)Except as otherwise provided in this subparagraph or in regulations, the term “market discount bond” shall not include any bond acquired by the taxpayer at its original issue.
(ii)Clause (i) shall not apply to any bond if—
(I)the basis of the taxpayer in such bond is determined under section 1012, and
(II)such basis is less than the issue price of such bond determined under subpart A of this part.
(iii)Clause (i) shall not apply to any bond issued pursuant to a plan of reorganization (within the meaning of section 368(a)(1)) in exchange for another bond having market discount. Solely for purposes of section 1276, the preceding sentence shall not apply if such other bond was issued on or before July 18, 1984 (the date of the enactment of section 1276) and if the bond issued pursuant to such plan of reorganization has the same term and the same interest rate as such other bond had.
(iv)For purposes of clause (i), if the adjusted basis of any bond in the hands of the taxpayer is determined by reference to the adjusted basis of such bond in the hands of a person who acquired such bond at its original issue, such bond shall be treated as acquired by the taxpayer at its original issue.
(2)(A)The term “market discount” means the excess (if any) of—
(i)the stated redemption price of the bond at maturity, over
(ii)the basis of such bond immediately after its acquisition by the taxpayer.
(B)In the case of any bond having original issue discount, for purposes of subparagraph (A), the stated redemption price of such bond at maturity shall be treated as equal to its revised issue price.
(C)If the market discount is less than ¼ of 1 percent of the stated redemption price of the bond at maturity multiplied by the number of complete years to maturity (after the taxpayer acquired the bond), then the market discount shall be considered to be zero.
(3)The term “bond” means any bond, debenture, note, certificate, or other evidence of indebtedness.
(4)The term “revised issue price” means the sum of—
(A)the issue price of the bond, and
(B)the aggregate amount of the original issue discount includible in the gross income of all holders for periods before the acquisition of the bond by the taxpayer (determined without regard to section 1272(a)(7)) or, in the case of a tax-exempt obligation, the aggregate amount of the original issue discount which accrued in the manner provided by section 1272(a) (determined without regard to paragraph (7) thereof) during periods before the acquisition of the bond by the taxpayer.
(5)The terms “original issue discount”, “stated redemption price at maturity”, and “issue price” have the respective meanings given such terms by subpart A of this part.
(b)(1)If the taxpayer makes an election under this subsection—
(A)section 1276 and 1277 shall not apply, and
(B)market discount on any market discount bond shall be included in the gross income of the taxpayer for the taxable years to which it is attributable (as determined under the rules of subsection (b) of section 1276).
(2)An election under this subsection shall apply to all market discount bonds acquired by the taxpayer on or after the 1st day of the 1st taxable year to which such election applies.
(3)An election under this subsection shall apply to the taxable year for which it is made and for all subsequent taxable years, unless the taxpayer secures the consent of the Secretary to the revocation of such election.
(4)The basis of any bond in the hands of the taxpayer shall be increased by the amount included in gross income pursuant to this subsection.
(c)The Secretary shall prescribe such regulations as may be necessary to carry out the purposes of this subpart, including regulations providing proper adjustments in the case of a bond the principal of which may be paid in 2 or more payments.
Legislative History
Notes & Related Subsidiaries
Editorial Notes
Amendments
2018—Subsec. (a)(4)(B). Pub. L. 115–141, § 401(c)(1)(G), struck out “or (b)(4)” after “1272(a)(7)”. Subsec. (b)(1). Pub. L. 115–141, § 401(a)(181), substituted “871(a),” for “871(a),,” in concluding provisions. 1993—Subsec. (a)(1)(B)(ii)–(iv). Pub. L. 103–66, § 13206(b)(2)(A)(i), redesignated cls. (iii) and (iv) as (ii) and (iii), respectively, and struck out heading and text of former cl. (ii). Text read as follows: “Any tax-exempt obligation (as defined in section 1275(a)(3)).” Subsec. (a)(1)(C), (D). Pub. L. 103–66, § 13206(b)(2)(A)(ii), (iii), added subpar. (C) and redesignated former subpar. (C) as (D). Subsec. (a)(4)(B). Pub. L. 103–66, § 13206(b)(2)(B)(ii), inserted before period at end “or, in the case of a tax-exempt obligation, the aggregate amount of the original issue discount which accrued in the manner provided by section 1272(a) (determined without regard to paragraph (7) thereof) during periods before the acquisition of the bond by the taxpayer”. Subsec. (b)(1). Pub. L. 103–66, § 13206(b)(2)(B)(i), substituted “section 103, 871(a),” for “section 871(a)” in last sentence. 1988—Subsec. (a)(4)(B). Pub. L. 100–647, § 1006(u)(2), substituted “section 1272(a)(7)” for “section 1272(a)(6)”. Subsec. (b)(4). Pub. L. 100–647, § 1018(c)(3), added par. (4). Subsec. (c). Pub. L. 100–647, § 1018(c)(2), inserted before period at end “, including
Regulations
providing proper adjustments in the case of a bond the principal of which may be paid in 2 or more payments”. 1986—Subsec. (a)(1)(B)(i). Pub. L. 99–514, § 1878(a), amended Pub. L. 98–369, § 1001(b), by adding a par. (24), effective as if included in Pub. L. 98–369. See 1984 Amendment note below. Subsec. (a)(1)(C). Pub. L. 99–514, § 1803(a)(6), added subpar. (C). Subsec. (a)(4). Pub. L. 99–514, § 1899A(32), substituted “means” for “means of” in introductory provisions. 1984—Subsec. (a)(1)(B)(i). Pub. L. 98–369, § 1001(b)(24), as added by Pub. L. 99–514, § 1878(a), substituted “6 months” for “1 year”, applicable to property acquired after June 22, 1984, and before Jan. 1, 1988. See
Effective Date
of 1984 Amendment note below.
Statutory Notes and Related Subsidiaries
Effective Date
of 2018 AmendmentAmendment by section 401(c)(1)(G) of Pub. L. 115–141 applicable to debt instruments issued on or after July 2, 1982, see section 401(c)(1)(H) of Pub. L. 115–141, set out as a note under section 163 of this title.
Effective Date
of 1993 Amendment
Amendments
by Pub. L. 103–66 applicable to obligations purchased (within the meaning of section 1272(d)(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 1803(a)(6) and 1878(a) of Pub. L. 99–514 effective, except as otherwise provided, as if included in the provisions of the Tax Reform Act of 1984, Pub. L. 98–369, div. A, to which such amendment relates, see section 1881 of Pub. L. 99–514, set out as a note under section 48 of this title.
Effective Date
of 1984 AmendmentAmendment by Pub. L. 98–369 applicable to property acquired after June 22, 1984, and before Jan. 1, 1988, see section 1001(e) of Pub. L. 98–369, set out as a note under section 166 of this title.
Effective Date
Section applicable to taxable years ending after July 18, 1984, except as otherwise provided, 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. § 1278
Title 26 — Internal Revenue Code
Last Updated
Apr 6, 2026
Release point: 119-73