Introduction
Understanding the tax treatment of interest on home construction loans is important for anyone planning to build a primary or secondary residence. While mortgage interest on an existing home is generally deductible, the rules for construction loans involve additional requirements and time-based limitations. Knowing how and when interest becomes deductible can help homeowners make informed financing decisions and avoid losing valuable tax benefits during the building process.
What is deductibility of interest paid on home construction loans?
Interest paid on the mortgage secured by an existing home is generally tax deductible (with certain limitations). However, there are some special rules regarding the deductibility of interest paid on mortgages taken to build a home.
Is interest on the money you borrow to build a home tax deductible?
In general, if the money from a construction loan is used toward the building of a primary or secondary residence, the loan is considered home acquisition debt. It is therefore deductible, subject to the limitations relating to such debt.
There are, however, a number of other limitations governing whether the interest on a construction loan will qualify for deduction. These limitations include the following:
- The interest is only deductible for a 24-month period prior to the house being ready for occupancy.
- You must be able to demonstrate that the loan proceeds were used specifically for the construction of the home. If part of the proceeds is used to purchase a lot, then the loan must be secured by the lot.
- If you begin construction on the home before a construction loan is incurred, then the loan is considered acquisition debt to the extent of money spent on construction during the 24-month period prior to your incurring the loan. The IRS will consider a loan incurred on the date that you submit a written loan application, as long as you receive the loan no more than 30 days after your loan is approved.
What if you pay interest on the loan before you begin construction?
If you pay interest on the loan before construction is commenced, the interest is considered personal and is therefore not deductible.
What if you don’t take a loan on the home until after construction is completed?
Interest on loans taken on a newly constructed home (up to 90 days after construction is completed) may be deductible if certain requirements are met. If the loan is taken more than 90 days after construction is completed, however, only the money spent on building the home during the 24 months prior to the date of completion is treated as acquisition debt. As such, interest on such debt is deductible.
Here, too, the IRS will consider a loan incurred on the date that you submit a written loan application (as long as you receive the loan no more than 30 days after your loan is approved).
Conclusion
Interest on a construction loan can qualify for a tax deduction if specific IRS guidelines are met. From how the loan proceeds are used to when the loan is incurred and when construction begins, each detail can impact the deductibility of interest. Proper planning and documentation are essential to ensure eligibility. If you are financing a home build, consulting with a tax professional can help you take full advantage of the deductions available and avoid costly errors in the process.
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Source:
Broadridge Investor Communication Solutions, Inc. prepared this material for use by Scarlet Oak Financial Services.
Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, legal, or retirement advice or recommendations. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on individual circumstances. Scarlet Oak Financial Services provide these materials for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.
