Deductible Interest

General Rules

Interest paid or incurred on debts related to your business generally is fully deductible as business interest. Business interest is deductible without limitation, except when such interest is required to be capitalized. (Remember, for example, that construction period interest and taxes must be capitalized, as explained earlier in this chapter.) There is 1 main exception to the general deductibility rule for business interest: interest on life insurance policies. (The limits on deducting interest with respect to life insurance policies are discussed in Chapter 22.)

Interest is characterized by how and for what the proceeds of the loan that generated the interest are used. Personal interest is nondeductible (except to the extent of qualified home mortgage interest and a limited amount of student loan interest). Investment interest is deductible only to the extent of net investment income. Interest characterized as incurred in a passive activity is subject to the passive loss rules. The characterization is not dependent on what type of property—business or personal—was used as collateral for the loan. For example, if you borrow against your personal life insurance policy and use the proceeds to buy equipment for your business, you can deduct the interest as business interest. On the other hand, if you take a bank loan using your corporate stock as collateral, and use the proceeds to invest in the stock market, the interest is characterized as investment ...

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