accrued market discount

Accrued market discount

The rise in the market value of a discount bond as it approaches maturity (when it is redeemable at par) and not because of falling market interest rates.

Accretion of Discount

The increase in value of a security or other instrument as it approaches maturity. For example, suppose one buys a bond with a face value of $100 and pays $89. Because one is guaranteed to receive $100 when the bond matures, its value gradually increases between the purchase date and maturity. This increase is called the accretion of discount.

accrued market discount

The gain in the value of a bond that occurs because the bond has been bought at a discount from face value. For example, a $1,000 par bond maturing in ten years and selling at $800 can be expected to rise gradually in price throughout its remaining life. The accrued market discount is the portion of any price rise caused by the gradual increase (as opposed to an increase caused by a fall in interest rates).
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Under the ratable method, the amount of accrued market discount is equal to the product of the total market discount and the ratio of days held to the total days between the acquisition and disposition date to the maturity date.
Section 1276 (b) (3) indicates that for installment notes "the amount of accrued market discount shall be determined under regulations prescribed by the Secretary." (29) Although this statute was enacted over a quarter century ago, no regulations have been issued.
The proposed regulations provide two exceptions to this rule: (1) The broker must assume the customer has elected to use a constant interest rate to determine the amount of accrued market discount, and (2) the broker must assume that the customer has elected to amortize the bond premium.
It is worth noting that, under current rules, the holder of a market discount bond does not have to annually include in gross income the accrued market discount.
(4) If the bond was issued after July 18, 1984, or if the bond was issued on or before July 18, 1984 and was purchased after April 30, 1993, and the purchase occurred on the market at a discount of % of 1% (.0025) or more of the stated redemption price at maturity times the number of years until maturity, a cash basis investor must include the market discount in income as it accrues if he has made an election to include accrued market discount with respect to that bond or other market discount obligations, as discussed in Q 7731.
Since the amount of market discount that accrues before the maturity of the debt instrument is always less with the constant-rate method than with the straight-line method, investors are always better off for tax purposes if they elect to use the constant-rate method to compute accrued market discount.
For a discount bond, the basis increases at the rate of the accrued market discount until it reaches the principal value at maturity.
Gain on the disposition of any market discount bond is treated as ordinary income to the extent it does not exceed the accrued market discount on the bond (Sec.
(4) If the bond was issued after July 18, 1984, or if the bond was issued on or before July 18, 1984 and was purchased after April 30, 1993, and the purchase occurred on the market at a discount of V of 1% (.0025) or more of the stated redemption price at maturity times the number of years until maturity, a cash basis investor must include the market discount in income as it accrues if he has made an election to include accrued market discount with respect to that bond or other market discount obligations, as discussed in Q 1110.
(Investors alternatively can elect to accrue market discount using the constant interest method.) For bonds purchased at a market discount after April 30, 1993, the gain realized on sale or redemption is ordinary income to the extent of the accrued market discount; any remaining gain is capital gain.
Therefore, securities partnerships purchasing market discount obligations listed under 1) and 2) above after April 30, 1993, must treat any resulting gain as taxable ordinary income to the extent of any accrued market discount.
If TIPS are purchased in a secondary market at a price below their adjusted principal, the holder reports accrued market discount as ordinary interest income, either annually or when the bond matures or is sold.