Constructing Your Home

• If you are an individual taxpayer and you take out a loan to finance the construction of a personal residence, you may qualify to deduct the interest as mortgage interest. The mortgage interest deduction is available if the lender takes a security interest in the home you construct, meaning it is on the title to your property and can foreclose on it if you fail to keep up with your loan payments. In addition to the security interest, the deduction is only available for the construction of a qualified home. A qualified home includes your main residence plus any other second home of your choosing, provided it's not a rental or investment property that you own to generate income rather than use for personal purposes. But if you obtain the construction loan by taking a cash advance from your credit card, the interest payments you make don't qualify as mortgage interest. This is because the credit card company has no security interest in the home you build.
  
  

Investment Interest Limitations

• The amount of interest you can deduct is different if you obtain the loan to construct an investment property, such as commercial rental real estate. The IRS requires you to separately calculate your net investment income first. Your net investment income is equal to all income you earn from all of your investments, minus all deductible investment expenses except the interest on loans, including your construction loan. Your annual interest deduction is limited to the new investment income you calculate.
  
  

Construction Businesses

• When your business engages in construction activities, then the interest you pay on construction loans is a business expense, and thus fully deductible. For example, suppose you are a contractor and a client hires you to build a home on her property. If you obtain a loan to purchase all the supplies you need and to pay your employees, then the interest payments qualify as a deductible business expense.
  
  

Reporting Interest Deduction

• The way you report your interest deduction also depends on which taxpayer category you fall under. For example, if you claim the mortgage interest deduction, or claim the interest as an investment expense, then you must report it on a Schedule A as an itemized deduction. However, businesses will take the deduction on the tax form appropriate for the type of entity. For example, if you operate an incorporated construction company, then you must report the expense directly on the company's Form 1120 or 1120A.