26 USC 1278 - Definitions and special rules

(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

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(i) Short-term obligations Any obligation with a fixed maturity date not exceeding 6 months 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.

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(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) the stated redemption price of the bond at maturity, over
(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 1/4 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) 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 (b)(4)) 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) sections 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). 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 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.
[1] So in original.