26 USC 1276 - Disposition gain representing accrued market discount treated as ordinary income

(a) Ordinary income 

(1) In general 
Except as otherwise provided in this section, gain on the disposition of any market discount bond shall be treated as ordinary income to the extent it does not exceed the accrued market discount on such bond. Such gain shall be recognized notwithstanding any other provision of this subtitle.
(2) Dispositions other than sales, etc. 
For purposes of paragraph (1), a person disposing of any market discount bond in any transaction other than a sale, exchange, or involuntary conversion shall be treated as realizing an amount equal to the fair market value of the bond.
(3) Treatment of partial principal payments 


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(A) In general 
Any partial principal payment on a market discount bond shall be included in gross income as ordinary income to the extent such payment does not exceed the accrued market discount on such bond.
(B) Adjustment 
If subparagraph (A) applies to any partial principal payment on any market discount bond, for purposes of applying this section to any disposition of (or subsequent partial principal payment on) such bond, the amount of accrued market discount shall be reduced by the amount of such partial principal payment included in gross income under subparagraph (A).
(4) Gain treated as interest for certain purposes 
Except for purposes of sections 103, 871 (a),,[1] 881, 1441, 1442, and 6049 (and such other provisions as may be specified in regulations), any amount treated as ordinary income under paragraph (1) or (3) shall be treated as interest for purposes of this title.
(b) Accrued market discount 
For purposes of this section
(1) Ratable accrual 
Except as otherwise provided in this subsection or subsection (c), the accrued market discount on any bond shall be an amount which bears the same ratio to the market discount on such bond as
(A) the number of days which the taxpayer held the bond, bears to
(B) the number of days after the date the taxpayer acquired the bond and up to (and including) the date of its maturity.
(2) Election of accrual on basis of constant interest rate (in lieu of ratable accrual) 

(A) In general 
At the election of the taxpayer with respect to any bond, the accrued market discount on such bond shall be the aggregate amount which would have been includible in the gross income of the taxpayer under section 1272 (a) (determined without regard to paragraph (2) thereof) with respect to such bond for all periods during which the bond was held by the taxpayer if such bond had been
(i) originally issued on the date on which such bond was acquired by the taxpayer,

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(ii) for an issue price equal to the basis of the taxpayer in such bond immediately after its acquisition.
(B) Coordination where bond has original issue discount 
In the case of any bond having original issue discount, for purposes of applying subparagraph (A)
(i) the stated redemption price at maturity of such bond shall be treated as equal to its revised issue price, and
(ii) the determination of the portion of the original issue discount which would have been includible in the gross income of the taxpayer under section 1272 (a) shall be made under regulations prescribed by the Secretary.
(C) Election irrevocable 
An election under subparagraph (A), once made with respect to any bond, shall be irrevocable.
(3) Special rule where partial principal payments 
In the case of a bond the principal of which may be paid in 2 or more payments, the amount of accrued market discount shall be determined under regulations prescribed by the Secretary.
(c) Treatment of nonrecognition transactions 
Under regulations prescribed by the Secretary
(1) Transferred basis property 
If a market discount bond is transferred in a nonrecognition transaction and such bond is transferred basis property in the hands of the transferee, for purposes of determining the amount of the accrued market discount with respect to the transferee
(A) the transferee shall be treated as having acquired the bond on the date on which it was acquired by the transferor for an amount equal to the basis of the transferor, and
(B) proper adjustments shall be made for gain recognized by the transferor on such transfer (and for any original issue discount or market discount included in the gross income of the transferor).
(2) Exchanged basis property 
If any market discount bond is disposed of by the taxpayer in a nonrecognition transaction and paragraph (1) does not apply to such transaction, any accrued market discount determined with respect to the property disposed of to the extent not theretofore treated as ordinary income under subsection (a)
(A) shall be treated as accrued market discount with respect to the exchanged basis property received by the taxpayer in such transaction if such property is a market discount bond, and
(B) shall be treated as ordinary income on the disposition of the exchanged basis property received by the taxpayer in such exchange if such property is not a market discount bond.
(3) Paragraph (1) to apply to certain distributions by corporations or partnerships 
For purposes of paragraph (1), if the basis of any market discount bond in the hands of a transferee is determined under section 732 (a), or 732 (b), such property shall be treated as transferred basis property in the hands of such transferee.
(d) Special rules 
Under regulations prescribed by the Secretary
(1) rules similar to the rules of subsection (b) of section 1245 shall apply for purposes of this section; except that
(A) paragraph (1) of such subsection shall not apply,
(B) an exchange qualifying under section 354 (a), 355 (a), or 356 (a) (determined without regard to subsection (a) of this section) shall be treated as an exchange described in paragraph (3) of such subsection, and
(C) paragraph (3) of section 1245 (b) shall be applied as if it did not contain a reference to section 351, and
(2) appropriate adjustments shall be made to the basis of any property to reflect gain recognized under subsection (a).
[1] So in original.