What Is Construction Interest Expense?
Construction interest expense is interest that accumulates on a construction loan used to construct a building or other long-lived business asset. Typically, interest paid on a loan is immediately expensed and is tax deductible. However, construction interest expense that is incurred during the period up until the time the asset begins to produce revenue is capitalized by adding it to the cost basis of the asset. Construction interest expense is treated differently than other types of business-related interest.
Construction Interest Expense Explained
Construction interest that is incurred on the construction of a structure intended for rental or business use is not deductible at the time that it is paid. This type of interest is added to the cost basis of the asset instead. For this reason, it is also known as capitalized interest.
Example of Construction Interest Expense
For example, XYZ corporation is building a new industrial-sized widget press. XYZ corporation takes out a loan to purchase the parts and erect the widget press. Until the time the widget press is fully functional and starts to produce widgets for sale, the interest on the loan to build the widget press will be added up, then added to the cost basis of the widget press where it will be part of the capitalized cost for the press. This is a different treatment from all of XYZ corporation's other outstanding loans, where the interest is categorized as an expense immediately and is tax deductible.