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Taxmap/pubs/p535-020.htm#TXMP13419819 When To   Deduct Interest

Interest Expense

If the uniform capitalization rules, discussed under Capitalization of Interest, earlier, do not apply to you, deduct interest as follows.

Taxmap/pubs/p535-020.htm#TXMP47d74d5a Cash method.

Under the cash method, you can generally deduct only the interest you actually paid during the tax year. You cannot deduct a promissory note you gave as payment because it is a promise to pay and not an actual payment.

Taxmap/pubs/p535-020.htm#TXMP281d1356 Prepaid interest.

You generally cannot deduct any interest paid before the year it is due. Interest paid in advance can be deducted only in the tax year in which it is due.

Taxmap/pubs/p535-020.htm#TXMP4df1bd5a Discounted loan.

If interest or a discount is subtracted from your loan proceeds, it is not a payment of interest and you cannot deduct it when you get the loan. For more information, see Original issue discount (OID) under Interest You Can Deduct, earlier.

Taxmap/pubs/p535-020.htm#TXMP17d5d782 Refunds of interest.

If you pay interest and then receive a refund in the same tax year of any part of the interest, reduce your interest deduction by the refund. If you receive the refund in a later tax year, include the refund in your income to the extent the deduction for the interest reduced your tax.

Taxmap/pubs/p535-020.htm#TXMP61360cea Accrual method.

Under an accrual method, you can deduct only interest that has accrued during the tax year.

Taxmap/pubs/p535-020.htm#TXMP3dd4feaf Prepaid interest.

You generally cannot deduct any interest paid before it is due. Instead, deduct it in the year in which it is due.

Taxmap/pubs/p535-020.htm#TXMP49dd2e80 Discounted loan.

If interest or a discount is subtracted from your loan proceeds, it is not a payment of interest and you cannot deduct it when you get the loan. For more information, see Original issue discount (OID) under Interest You Can Deduct, earlier.

Taxmap/pubs/p535-020.htm#TXMP7b253e95 Tax deficiency.

If you contest a federal income tax deficiency, interest does not accrue until the tax year the final determination of liability is made. If you do not contest the deficiency, then the interest accrues in the year the tax was asserted and agreed to by you.

However, if you contest but pay the proposed tax deficiency and interest, and you do not designate the payment as a cash bond, then the interest is deductible in the year paid.

Taxmap/pubs/p535-020.htm#TXMP58f199a1 Related person.

If you use an accrual method, you cannot deduct interest owed to a related person who uses the cash method until payment is made and the interest is includible in the gross income of that person. The relationship is determined as of the end of the tax year for which the interest would otherwise be deductible. If a deduction is denied under this rule, the rule will continue to apply even if your relationship with the person ceases to exist before the interest is includible in the gross income of that person. See Related Persons in Publication 538.

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