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To actually claim the deduction for investment interest expenses, you must itemize your deductions. Investment interest goes on Schedule A, under "Interest You Paid." You may also have to file Form 4952, which provides details about your deduction.
Interest on a construction loan is not deductible,. This interest is added to the basis of the property and depreciated with the building. If there is a delay in starting construction of the loan, for example you get the loan on January 1 but because of legal issues the construction does not start until June, you may deduct the interest from January to June. Once construction starts the interest becomes a part of the basis.
You may deduct as a business expense the interest you pay on the loan both before and after the construction period. But you may not deduct the interest you pay during the construction period. Instead, this cost must be added to the basis of your property and depreciated over 27.5 years (the depreciation period for residential rental property). (I.R.C. § 263A(f)(1).)
The construction period for real property begins when physical construction starts. Physical construction includes:
The construction period ends when all production activities reasonably expected to be done are completed and the property is placed in service—that is, made available for rent.
Activities such as planning and design, preparing architectural blueprints, or obtaining building permits do not constitute physical construction. Thus, interest paid while these activities are going on, but before physical construction is done, can be currently deducted as an operating expense.
You don't enter the 1098. You will add the interest to the cost basis of your investment property. If it is going to be a rental property, you will start deducting the interest on the date the property is placed in service (made available for rent). If you are going to sell the property, you will not deduct any of the interest - it will all be added to your cost basis.
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