Title 26, Internal Revenue CodeRelease 119-110
§1278 Definitions and Special Rules
Title 26 › Subtitle A — Income Taxes › CHAPTER 1 — NORMAL TAXES AND SURTAXES › Subchapter P — Capital Gains and Losses › PART V — SPECIAL RULES FOR BONDS AND OTHER DEBT INSTRUMENTS › Subpart B — Market Discount on Bonds › § 1278
Summary
Defines which bonds have "market discount," how to measure it, and an option to include that discount in income now. Market discount bond: a bond that has market discount, but not short-term debt (matures in 1 year or less), U.S. savings bonds, certain installment-sale obligations, or usually bonds the buyer got at the original issue. There are special rules if the bond came from a reorganization (with a carve‑out for bonds issued on or before July 18, 1984 that keep the same term and rate) and if your basis is traced to someone who bought at original issue. Market discount: the amount the bond’s stated payoff at maturity exceeds your cost when you bought it. For bonds with original issue discount, use a "revised issue price" instead of the stated payoff. Very small discounts are ignored if they are under 0.25% of the payoff times the years left. "Bond" means any note, debenture, certificate, or other debt paper. Other technical terms are defined the same way as in the related bond rules. A taxpayer can elect to include market discount in income as it accrues. That election applies to all market discount bonds bought on or after the first day of the taxable year the election is made, stays in effect for later years unless the IRS agrees to let it be revoked, treats the included amounts as interest for most tax rules, and increases the bond’s basis by the amount included. The Treasury must issue regulations to implement these rules, including for bonds with principal paid in multiple payments.
Full Legal Text
Title 26, §1278
Internal Revenue Code, Source: USLM XML via OLRC
(a)In general
For purposes of this part—
(1)Market discount bond
(A)In general
Except as provided in subparagraph (B), the term “market discount bond” means any bond having market discount.
(B)Exceptions
The term “market discount bond” shall not include—
(i)Short-term obligations
Any obligation with a fixed maturity date not exceeding 1 year from the date of issue.
(ii)United States savings bonds
Any United States savings bond.
(iii)Installment obligations
Any installment obligation to which section 453B applies.
(C)section 1277 not applicable to tax-exempt obligations
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)Treatment of bonds acquired at original issue
(i)In general
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)Treatment of bonds acquired for less than issue price
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)Bonds acquired in certain reorganizations
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)Treatment of certain transferred basis property
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)Market discount
(A)In general
The term “market discount” means the excess (if any) of— (i)
(ii)the basis of such bond immediately after its acquisition by the taxpayer.
(B)Coordination where bond has original issue discount
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)De minimis rule
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)Bond
The term “bond” means any bond, debenture, note, certificate, or other evidence of indebtedness.
(4)Revised issue price
The term “revised issue price” means the sum of— (A)
(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)Original issue discount, etc.
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)Election to include market discount currently
(1)In general
If the taxpayer makes an election under this subsection— (A)
(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).
Except for purposes of section 103, 871(a), 881, 1441, 1442, and 6049 (and such other provisions as may be specified in regulations), any amount included in gross income under subparagraph (B) shall be treated as interest for purposes of this title.
(2)Scope of election
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)Period to which election applies
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)Basis adjustment
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)Regulations
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
Sep 22, 2026
Release point: 119-110