Get your taxes done using TurboTax

You have a choice.  First, you can choose to add this to the cost basis of the bond which would reduce gain on the redemption/sale in the future.  

Or, if you choose to reduce the tax exempt interest by the premium paid for the bond, it must be amortized as described below.

If you acquired a tax-exempt bond at a premium, you are only required to report the net amount of tax-exempt interest (that is, the excess of the tax-exempt interest received during the year over the amortized bond premium for the year).

Amortizable bond premium. 

If you elect to reduce your interest income on a taxable bond by the amount of taxable amortizable bond premium. But identify the amount to be subtracted as "ABP Adjustment.".  The premium is amortized over the life of the bond on a pro-rata basis.

However, if the payer reported to you a net amount of interest income on the bond reflecting the offset of the gross amount of interest income by the amortizable bond premium, no reduction of the amount of interest income reported to you by the payer is needed on Schedule B for the bond.

Follow these steps to make a manual adjustment for the bond premium you paid on your tax-exempt and taxable bonds:

1. Select Federal Taxes
2. Under Wages & Income select Interest on 1099-INT
3. Enter your 1099-INT information, select Continue
4. Select I need to adjust the taxable amount, select Continue
5. Enter the state that pays your tax-exempt interest, select Continue
6. Enter the amount of your premium adjustment (use a negative number if you need to add to the interest reported)
7. Select the Reason for Adjustment - ABP Adjustment
8. See the image below.