The premium must be amortized on tax-exempt bonds using the constant yield method. This is necessary to reduce the bondholder’s tax basis in the tax-free bond to determine if there is a capital gain upon disposition.
As long as the bond is held to maturity, there will be no capital gain or loss associated with the bond. If the bond is sold before maturity, you may have capital gain or loss based is the portion of the premium which has not yet been amortized.
No tax deduction is allowed for premium amortization since the interest is not taxable, but if the bonds are taxable bonds, the taxable income can be reduced by the amount of premium amortization.
Per IRS Publication 550, page 34:
"If the bond yields tax-exempt interest, you must amortize the premium. This amortized amount is not deductible in determining taxable income. However, each year you must reduce your basis in the bond (and tax-exempt interest otherwise reportable on Form 1040, line 8b) by the amortization for the year. For a tax-exempt covered security acquired at a premium, box 13 shows the amount of bond premium amortization allocable to the interest paid during the tax year. If a net amount of interest appears in box 8 or 9, whichever is applicable, box 13 will be blank. Bond premium. Bond premium is the amount by which your basis in the bond right after you get it is more than the total of all amounts payable on the bond after you get it (other than payments of qualified stated interest). For example, a bond with a maturity value of $1,000 generally would have a $50 premium if you buy it for $1,050."
For further information, please see IRS Publication 550 "Investment Income and Expenses (Including Capital Gains and Losses) at the following link: <a rel="nofollow" target="_blank" href="
https://www.irs.gov/pub/irs-pdf/p550.pdf">https://www.irs.gov/pub/irs-pdf/p550.pdf</a>
