Rev. Rul. 74-482

Advice has been requested concerning the allocation of interest between the seller and the purchaser of tax-exempt bonds under the circumstances described below.

X corporation, a dealer in municipal bonds doing business in State M, purchased certain tax-exempt municipal bonds on September 1, 1972.

On September 15, 1972, X agreed to sell the bonds, and delivered a written confirmation of the sale to Y, its customer, who signed and returned it to X on the same day. The confirmation stated the sales price of the bonds and the amount of accrued interest to be paid by Y. The accrued interest date was computed from the last coupon date to September 25, 1972, which was the settlement date specified in the confirmation. The settlement date was negotiated between X and Y and represented the earliest date on which Y could be required to pay for the bonds. Under the terms of the confirmation, the settlement date and the interest computation remained fixed regardless of the actual dates of delivery and payment. The confirmation also provided that payment was not required until Y received the bonds or until settlement date, whichever was later, but did not specify when ownership of the bonds was transferred from X to Y.

On September 20, 1972, X's bank mailed the bonds to Y with a sight draft attached. Y paid the sight draft on September 25, 1972, the agreed settlement date. Under the laws of State M, ownership of the bonds passed to Y on September 20, 1972, the date on which delivery occurred, since X and Y did not contract otherwise. In computing its Federal income tax liability for 1972, X treated the interest accrued from September 1, 1972 to September 25, 1972, as interest income that was tax-exempt under section 103 of the Internal Revenue Code of 1954.

Section 61(a)(3) of the Code provides that gross income includes gains derived from dealings in property. Section 103(a)(1) provides that interest on certain obligations is not includible in gross income.

In American National Bank of Austin v. United States, 421 F.2d 442 (5th Cir. 1970), cert. denied, 400 U.S. 819 (1970), the United States Court of Appeals held that only the owner of obligations described in section 103 of the Code may treat the interest accruing on such obligations as exempt from taxation.

Section 1001(a) of the Code provides that gain from the sale or other disposition of property is the excess of the amount realized therefrom over the adjusted basis provided in section 1011, and that loss is the excess of the adjusted basis of the property over the amount realized. Section 1001(b) provides that the amount realized from the sale or other disposition of property is the sum of any money received plus the fair market value of any property received.

In the instant case, since X was not the owner of the bonds after September 20, 1972, the allocation of interest to him until September 25, 1972, by agreement of Y, the owner of the bonds during this period, was a payment of money by Y to X as part of the sales transaction, and is thus an additional amount realized by X on the sale of the bonds under section 1001 of the Code. With respect to X, such payment is not interest on the bonds.

Interest on the bonds that accrued after ownership passed to Y (September 20, 1972) belongs to Y and is exempt from taxation under section 103 of the Code. Y's basis in the bonds includes the payment, pursuant to the agreement, of such interest to X.

If the settlement date had preceded the delivery date, the interest that would have accrued between such dates and would have been allocated to Y pursuant to the agreement would have belonged to X, the owner of the bonds during this period, and would have been tax exempt under section 103 of the Code. This amount would have also effected a reduction of the amount realized on the sale by X and a corresponding reduction in Y's basis in the bonds.