¹Regs. Sec. 1.1273-1(d) sets forth a de minimis rule that treats OID as zero unless it exceeds 0.0025 times the product of the instruments stated redemption price at maturity times the number of years to maturity from the issue date.

²A holder may, however, elect under Sec. 1278(b) to include a market discount as income over the period he or she holds the instrument, either under a ratable accrual or under the constant-interest method.

³See Regs. Sec. 1.1272-2(b)(2).

⁴Curiously, Regs. Sec. 1.1272-2(b)(3) limits the definition of a secondary market acquisition premium to an instrument acquired with a basis both (1) less than or equal to the principal amount payable under the debt and (2) greater than its AIP (i.e., when the market rate at acquisition is less than the rate on which the OID was based, but still greater than the instruments face rate).

⁵A taxpayer who pays a premium in the secondary market (an acquisition premium) would amortize it under the constant-yield method as an offset against interest income. According to Regs. Sec. 1.1275-7(f)(3), the bond premium paid for an inflation-indexed security is determined by assuming that the amount payable at maturity equals the inflation-adjusted principal amount on the day the holder acquires it. A discount on a secondary market acquisition (a market discount), on the other hand, would, at the taxpayers option, either be (1) treated as ordinary income to the extent of accrued market discount at the time the taxpayer redeems or otherwise disposes of the instrument; or (2) accrued as interest income ratably over the period he or she holds the bond. The market discount is the excess of an instruments stated redemption price at maturity over the price paid in the secondary market. For an inflation-indexed security, the stated redemption price would include the principal amount as of the acquisition date, adjusted for inflation.

⁶The regulations provide that a positive inflation adjustment for any period is OID, thereby implying that the holder is required to include only a portion of the adjustment in ordinary income for the year in which the adjustment arose (i.e., a manner consistent with the accrual of OID under the constant-yield method).The Example at Regs. Sec. 1.1275-7(d)(5) clearly requires that the entire adjustment be included as ordinary income in that year.

⁷See Regs. Sec.1.1275-7(c)(5) for the definition of a minimum guarantee payment.

⁸Premiums paid for inflation-indexed securities are treated somewhat differently, depending on whether they arose at original issue or in the secondary market. The difference results from the fact that the discount method (which applies to instruments originally issued at a price other than par) combines the premium amortization and the inflation adjustment in one formula; the coupon method (which applies only to instruments originally issued at par) takes them into account separately.

⁹The definition of premium applies both to instruments purchased at original issue and to those acquired in subsequent transactions; see Regs. Sec. 1.1272-2(b)(2).

¹⁰The regulations provide that a debt instrument is purchased at a premium if its adjusted basis, immediately after its purchase by the holder (including a purchase at original issue), exceeds the sum of all amounts payable on the instrument after the purchase date, other than payments of qualified stated interest.

¹¹Id.

¹²According to Regs. Sec.1.1275-7(f)(3), a holder determines the amount of acquisition premium or market discount on an inflation-indexed debt instrument by reference to the instruments AIP on the date acquired.