When To Deduct Interest

If the uniform capitalization rules, discussed earlier, do not apply to you, deduct interest as follows.

Cash method. In general, you can deduct only the interest you actually paid during the tax year. You cannot deduct a promissory note you gave as payment because it is a promise to pay and not an actual payment.

Prepaid interest. Under the cash method, you generally cannot deduct any interest paid before the year it is due. Interest paid in advance can be deducted only in the tax year in which it is due.

Discounted loan. If interest or a discount is subtracted from your loan proceeds, it is not a payment of interest and you cannot deduct it when you get the loan.

For more information, see Original issue discount (OID) under Interest You Can Deduct, earlier.

Refunds of interest. If you pay interest and then receive a refund in the same tax year of any part of the interest, reduce your interest deduction by the refund. If you receive the refund in a later tax year, include the refund in income if the deduction for the interest reduced your tax. You should include in income only the interest deduction that reduced your tax.

Accrual method. You can deduct only interest that has accrued during the tax year.

Prepaid interest. Under the accrual method, you generally cannot deduct any interest paid before it is due. Instead, deduct it in the year in which it is due.

Discounted loan. If interest or a discount is subtracted from your loan proceeds, it is not a payment of interest and you cannot deduct it when you get the loan. For more information, see Original issue discount (OID) under Interest You Can Deduct, earlier.

Tax deficiency. If you contest a federal income tax deficiency, interest does not accrue until the tax year the final determination of liability is made. If you do not contest the deficiency, then the interest accrues in the year the tax was asserted and agreed to by you.

However, if you contest but pay the proposed tax deficiency and interest, and you do not designate the payment as a cash bond, then the interest is deductible in the year paid.

Related person. If you use the accrual method, you cannot deduct interest owed to a related person who uses the cash method until payment is made and the interest is includible in the gross income of that person. The relationship is determined as of the end of the tax year for which the interest would otherwise be deductible. If a deduction is denied under this rule, the rule will continue to apply even if your relationship with the person ceases to exist before the interest is includible in the gross income of that person. See Related Persons in Publication 538.

Previous| First | Next

Publication Index | IRS-Forms Main | Home