Treas. Reg. § 1.1273-2: Determining Issue Price of Debt

Treasury Regulation § 1.1273-2 provides the specific rules for establishing the “issue price” of various debt instruments. This figure is the basis for tax rules concerning Original Issue Discount (OID). OID occurs when a debt instrument is issued for an amount less than what it will be worth at maturity, and the resulting discount is treated as a form of interest.

Determining an accurate issue price is important for both the issuer of the debt and the person who holds it. For the issuer, it dictates the amount of interest expense they can deduct over the life of the debt. For the holder, it determines the amount of interest income they must recognize, often before any cash is received. This regulation ensures the economic reality of the interest is accounted for systematically over the debt’s term, regardless of when the stated interest is actually paid.

Defining Issue Price and Issue Date

The “issue price” is the value assigned to a debt instrument when it is first sold to the public. This price serves as the baseline for all OID calculations and represents the cash or fair market value of property the issuer received.

The “issue date” is the date on which the debt instrument is first sold. This date establishes the point in time for valuing property or determining market conditions that affect the issue price.

OID exists if the issue price is lower than the debt’s “stated redemption price at maturity.” This redemption price is the total amount the issuer must pay the holder at maturity, not including certain periodic interest payments. The difference is OID, which is effectively a form of interest that must be recognized for tax purposes over the instrument’s life.

Determining Issue Price for Debt Instruments Issued for Money

When a company or government entity issues a debt instrument for cash, the rules are direct. If a “substantial amount” of the debt instruments in an issue is sold for money, the issue price for every instrument in that issue is the first price at which that substantial amount was sold. This rule creates a uniform issue price for identical bonds sold as part of the same offering.

A “substantial amount” is often interpreted as the first 10% of the debt issue sold to the public. For example, if a corporation issues $50 million worth of bonds, the price established by the sale of the first $5 million of those bonds will set the issue price for all $50 million, even if market conditions change and subsequent bonds are sold at slightly different prices.

The regulation also clarifies who constitutes the “public” for this test. Sales to bond houses, brokers, underwriters, or similar intermediaries acting as placement agents are disregarded. The issue price is only established when the debt is sold to the ultimate investors. If the first 10% of an issuance is sold to various investors for $990 per bond, then $990 becomes the issue price for the entire issuance.

Determining Issue Price for Debt Instruments Issued for Publicly Traded Property

When debt is issued in exchange for property instead of cash, the rules to determine the issue price hinge on whether the debt or the property is “publicly traded.”

The first rule applies if the debt instrument itself is publicly traded. If a substantial amount of the debt is traded on an established market, its issue price is its fair market value as of the issue date. The market’s valuation of the debt instrument is considered the most reliable measure of the transaction’s value, even if it was exchanged for non-traded property.

If the debt instrument is not publicly traded, the focus shifts to the property received in the exchange. If the debt is issued for property that is itself traded on an established market, the issue price of the debt is the fair market value of that property. A common example is a company issuing a new, non-traded bond in exchange for shares of a publicly-traded stock, where the bond’s value is determined by the stock’s market price.

The definition of “publicly traded property” is specific, including property listed on a national securities exchange, an interdealer quotation system, or certain foreign exchanges. It can also apply if price quotes are readily available from dealers, brokers, or pricing services. The regulations provide detailed timing rules, generally looking at a 31-day period around the issue date to ensure the valuation is based on consistent market activity.

The issuer’s determination of fair market value is binding on all holders, unless a holder explicitly discloses a different determination on their tax return.

Special Rules for Investment Units

A debt instrument is sometimes sold not by itself but bundled with another financial instrument, such as a stock warrant or an option. This package is known as an “investment unit” and is sold for a single price. The regulation provides a two-step process for assigning an issue price to the debt component.

The first step is to determine the issue price of the entire investment unit as a whole. This is done by applying the standard rules as if the unit were a single instrument. For instance, if the unit was sold for cash, its issue price is the first price at which a substantial amount of the units were sold to the public.

Once the total issue price for the unit is established, the second step is to allocate that price between the components. The allocation must be based on the relative fair market value of each component as of the issue date. To do this, the issuer must determine the standalone fair market value of the debt instrument and the other property.

For example, a corporation issues an investment unit consisting of one bond and one warrant for a total price of $1,000. If on the issue date, the fair market value of the bond by itself is $920 and the warrant is $80, the $1,000 issue price is allocated accordingly. This assigns an issue price of $920 to the bond, which is the amount used for calculating any OID.

Treasury Securities and Reopenings

The U.S. Department of the Treasury has specific rules for its securities. For Treasury securities sold to the public via auction, the issue price is the price equivalent to the highest accepted yield from competitive bids. This establishes a single price for all securities in that offering.

A “qualified reopening” occurs when the Treasury issues additional amounts of a previously issued security. Rather than creating a new security, it sells more of an existing one, increasing the supply of that specific bond or note.

For tax purposes, this simplifies accounting for both the Treasury and investors. The debt instruments sold in the reopening are treated as having the same issue price and issue date as the original securities. This treatment means the new securities are fungible with the original batch for tax calculations, even if sold on a later date.