J.K. Lasser's Your Income Tax 2013: For Preparing Your 2012 Tax Return

15.13 Year To Claim an Interest Deduction

As a cash-basis taxpayer, you deduct interest in the year of payment except for prepayments of interest (15.14). Giving a promissory note is not considered payment. Increasing the amount of a loan by interest owed, as with insurance loans, is also not considered payment and will not support a deduction. However, an accrual-basis taxpayer generally deducts interest in the year the interest accrues (40.3).

Here is how a cash-basis taxpayer treats interest in the following situations:

On a life insurance loan, where proceeds are used for a deductible (nonpersonal) purpose, you claim a deduction in the year in which the interest is paid. You may not claim a deduction when the insurance company adds the interest to your debt. You may not deduct your payment of interest on an insurance loan after you assign the policy.

On a margin account with a broker, interest is deductible in the year in which it is paid or your account is credited after the interest has been charged. But an interest charge to your account is not payment if you do not pay it in cash or the broker has not collected dividends, interest, or security sales proceeds that may be applied against the interest due. Note that the interest deduction on margin accounts is subject to investment interest limitations (15.10).

For partial payment of a loan used for a deductible (nonpersonal) purpose, interest is deductible in the year the payment is credited against interest due. When a loan ...