What is construction period interest?

The interest capitalization of the construction period represents the cost of financing the construction of a long-term asset, such as a rental building. Construction interest expenses are also called capitalized interest. If you borrow money to build commercial property, such as an apartment building, you are not entitled to the mortgage interest deduction. However, you can deduct as a business expense the interest you pay on the loan both before and after the construction period.

However, you can't deduct the interest you pay during the construction period. Instead, this cost must be added to the base of your property and amortized over 27.5 years (the depreciation period of a residential rental property). The Tax Reform Act of 1976 prohibited the immediate deduction of interest and taxes during the construction period of real estate, and required that interest and taxes be capitalized at the original cost of the built property and amortized over 10 years. As long as the home becomes your primary or second home on the day it's ready to be occupied, you can deduct all the interest you paid on the construction loan within 24 months before the house was finished.

Capitalized interest is the cost of funds used to finance the construction of a long-term asset that an entity builds for itself. If the entity is building several parts of a project and can use some parts while construction continues elsewhere, then it should stop capitalizing on the costs of borrowing on the parts it completes. An example of such a situation is when an organization builds its own corporate headquarters, using a construction loan to do so. After 10 years, the Tax Reform Act of 1986 prohibited the immediate deduction of all expenses during the construction period, as well as interest and taxes during the construction period, and eliminated the 10-year amortization rule.

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