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Is Home Construction Loan Interest Tax Deductible?

When you take out a mortgage and use the money to purchase a land so that you can construct a qualified home on it, the IRS still lets you to take the mortgage interest deduction for the interest payments you make during the year. The tax law, however, does place more restrictions on the mortgage interest deduction up until construction of the home is complete.

Deducting Construction Loan Interest

Key to taking an interest deduction is constructing a “qualified home” on the land. Under the tax code, qualified homes include your main home plus any second home of your choosing, provided it’s used for personal purposes – like a vacation home. In addition, your bank must take a security interest in the land and all structures you build on it.

Deductible Interest During Construction

You don’t need to wait until construction of your home is finished to begin deducting the interest on your construction loan. The IRS lets you deduct the interest during each phase of construction, provided construction doesn’t exceed 24 months. Your 24-month period begins on the first day construction activities commence. To maximize the amount of mortgage interest you can deduct, it’s important that construction starts shortly after you receive the mortgage funds. Any interest payments you make between receiving the funds and the start of construction isn’t deductible. Moreover, if construction lasts longer than 24 months, interest that accrues after the two years, until construction of the home is complete, is nondeductible.

Post Construction Interest

Once construction ceases and you’re ready to move in, you continue taking ordinary mortgage interest deductions on your tax returns each year. The IRS limits your deduction to the amount of interest that accrues on no more than $1 million of mortgage loans. Therefore, if you have a mortgage of $1.2 million and use it to purchase land to build your home on, interest accruals on $200,000 isn’t deductible.

Maximum Mortgage Interest

One thing to be aware of is that the $1 million limitation isn’t on a per-mortgage basis. For example, if you have another personal residence that you have an outstanding mortgage for, you must combine the balance from that mortgage with the amount of your construction loan to assess whether some of your interest payments are nondeductible.

Reference: IRS Publication 936-Home Mortgage Interest Deduction