Accrued Interest and Bond Premiums

If you purchased a bond between interest dates and paid some accrued interest to the seller, this interest is taxable to the seller. If you find that it has been reported to you on a 1099-INT Form, you should, as your last item reported in the Line 1 area of Schedule B, take a subtotal of all reported interest, and then subtract the amount of accrued interest that was paid and is rightfully taxable to others. Be sure to label the amount you subtract "accrued interest." The remainder of the interest will be reported on Line 2.

Amortizable bond premiums. If you paid a premium to buy a bond (that is, you paid more than the bond's face value, most likely because the bond's stated interest rate is higher than the current interest rate at the time you bought it), you can make the election to deduct a portion of the premium each year while you hold the bond.

If you make this election, you must make it for every bond you own and for every bond you purchase in the future, until you revoke the election. You'll probably need the assistance of your accountant or financial advisor in determining the amount of amortization to deduct. If the bond was acquired after 1987, you can deduct this amount from the rest of your interest income on Line 1 of Schedule B. Take a subtotal of your interest income, subtract the amortizable bond premium (label it "ABP") and report the remaining interest on Line 2.

If the bond is a tax-exempt issue, you must amortize any premium you paid in your own records, but you can't deduct the amortization. Instead, it will reduce your tax basis in the bond and will potentially increase your capital gains when you sell the bond.