Interest Deduction

Treated as follows:

Investment interest: Investment interest deductions are limited to net investment income.

Construction interest: Interest incurred during the construction and development of most real estate (but not a personal residence) must be capitalized and deducted over its depreciable life, beginning when the property is ready to be placed in service or sold.

Business interest: Interest incurred in an active trade or business in which the investor materially participates is fully deductible.

Housing interest: Interest on up to $1 million of acquisition debt (used to purchase or improve a home) plus $100,000 of home equity debt is tax deductible. This may be claimed for a principal residence plus one vacation home.

Consumer interest: Interest on credit cards and auto loans is not deductible.

Investment Interest. Investment interest deductions are limited to net investment income, which includes interest, dividends, long-term capital gains and income or loss from working interests in oil and gas interests. However, net investment income includes neither rental nor other passive activity income or loss, nor interest paid to buy an ownership in a passive activity.

Construction Interest. Interest incurred during the construction and development of most real estate (but not a personal residence) must be capitalized, and deducted over its depreciable life beginning when the property is ready to be placed in service or sold.

Business Interest. Interest incurred in an active trade or business in which the investor materially participates is fully deductible.

Housing Interest. Interest on up to $1 million of acquisition debt (used to purchase or improve a home) plus $100,000 of home equity debt is tax deductible. This may be claimed for a principal residence plus one vacation home (provided the owner used it personally for the greater of 14 days or 10% of the time it is rented). Debt incurred before October 13, 1987, is not subject to the $1 million limit.

Points paid on a mortgage to acquire a principal residence may be deductible if they are customary in the geographic area; points paid for other purposes such as refinancing are amortized (deducted evenly each year over the life of the loan) rather than deducted currently.

Consumer Interest. Interest on credit cards and auto loans is not deductible.

Individual: itemized interest deduction on Schedule A of Form 1040. Interest can be only for the taxpayer's own debt and not for that of another individual. The taxpayer can deduct interest on a home mortgage for the principal residence and, within limits, for a second residence. Interest on a margin account with a broker is also deductible to the extent it offsets investment income.

Corporation: interest expense for business purposes that is tax deductible. Prepaid interest, however, is not deductible in the year of payment but has to be allocated over the period to which the interest amounts relate, irrespective of whether the cash basis or accrual basis is used.