§ 1277.
(b)
Disallowed deduction allowed for later years
(1)
Election to take into account in later year where net interest income from bond
(A)
In general
If—
(i)
there is net interest income for any taxable year with respect to any market discount bond, and
(ii)
the taxpayer makes an election under this subparagraph with respect to such bond,
any disallowed interest expense with respect to such bond shall be treated as interest paid or accrued by the taxpayer during such taxable year to the extent such disallowed interest expense does not exceed the net interest income with respect to such bond.
(B)
Determination of disallowed interest expense
For purposes of subparagraph (A), the amount of the disallowed interest expense—
(i)
shall be determined as of the close of the preceding taxable year, and
(ii)
shall not include any amount previously taken into account under subparagraph (A).
(2)
Remainder of disallowed interest expense allowed for year of disposition
(B)
Nonrecognition transactions
If any market discount bond is disposed of in a nonrecognition transaction—
(i)
the disallowed interest expense with respect to such bond shall be treated as interest paid or accrued in the year of disposition only to the extent of the amount of gain recognized on such disposition, and
(ii)
the disallowed interest expense with respect to such property (to the extent not so treated) shall be treated as disallowed interest expense—
(I)
in the case of a transaction described in section 1276(c)(1), of the transferee with respect to the transferred basis property, or
(II)
in the case of a transaction described in section 1276(c)(2), with respect to the exchanged basis property.
(C)
Disallowed interest expense reduced for amounts previously taken into account under paragraph (1)
(3)
Disallowed interest expense
(c)
Net direct interest expense
For purposes of this section, the term “net direct interest expense” means, with respect to any market discount bond, the excess (if any) of—
(1)
the amount of interest paid or accrued during the taxable year on indebtedness which is incurred or continued to purchase or carry such bond, over
(2)
the aggregate amount of interest (including original issue discount) includible in gross income for the taxable year with respect to such bond.
In the case of any financial institution which is a bank (as defined in section 585(a)(2)), the determination of whether interest is described in paragraph (1) shall be made under principles similar to the principles of section 291(e)(1)(B)(ii). Under rules similar to the rules of section 265(a)(5), short sale expenses shall be treated as interest for purposes of determining net direct interest expense.
(Added [Pub. L. 98–369, div. A, title I, § 41(a)], July 18, 1984, [98 Stat. 545]; amended [Pub. L. 99–514, title IX], §§ 901(d)(4)(F), § 902(e)(2), title XVIII, § 1899A(29)–(31), Oct. 22, 1986, [100 Stat. 2380], 2382, 2960; [Pub. L. 100–647, title I, § 1018(u)(31)], Nov. 10, 1988, [102 Stat. 3592]; [Pub. L. 103–66, title XIII, § 13206(b)(1)(B)], Aug. 10, 1993, [107 Stat. 465]; [Pub. L. 104–188, title I, § 1616(b)(14)], Aug. 20, 1996, [110 Stat. 1857].)