26 U.S.C. § 163 — Interest

(a) General rule You may deduct all interest you pay or accrue during the tax year on a debt. (b) Installment purchases where the interest charge is not separately stated (1) General rule: Say you buy personal property or educational services under a contract that (A) lets you pay part or all of the price in installments, and (B) separately lists "carrying charges," but you cannot figure out the actual interest rate. In that case, treat the installment payments you make during the year as if 6 percent of the average unpaid balance were interest. To find that average: add up the unpaid balance on the first day of each month of the tax year, then divide by 12. "Educational services" means a service, including lodging, that a school described in section 170(b)(1)(A)(ii) provides for its own student. (2) Limitation: The amount you can treat as interest this way cannot exceed the total carrying charges actually tied to that tax year. (c) Redeemable ground rents Payments of annual or periodic rent under a "redeemable ground rent" are treated as interest on a mortgage-secured debt — but amounts you pay to redeem (buy out) the ground rent itself do not count. (d) Limitation on investment interest (1) In general: If you are not a corporation, you can deduct investment interest only up to your net investment income for the year. (2) Carryforward of disallowed interest: Any investment interest you cannot deduct this year, because of the limit in (1), is treated as investment interest paid or accrued next year instead. (3) What counts as "investment interest": (A) In general, it is any interest that would be deductible under this chapter (ignoring the limit in (1)) on debt properly tied to property held for investment. (B) It does not include: (i) qualified residence interest (defined in subsection (h)(3)); or (ii) interest counted under section 469's passive-activity rules. (C) It does include amounts deductible in connection with personal property used in a short sale. (4) "Net investment income": (A) It is investment income minus investment expenses. (B) "Investment income" is the sum of: (i) gross income from property held for investment (not counting gain covered by (ii)(I)); plus (ii) the amount, if any, by which the net gain from selling investment property exceeds the net capital gain figured using only investment-property sales; plus (iii) however much of that net capital gain (or, if smaller, that net gain) you elect to count. Qualified dividend income counts as investment income only if you elect to treat it that way. (C) "Investment expenses" are the deductions (other than interest) directly tied to producing investment income. (D) Income and expenses counted under section 469's passive-activity rules do not count as investment income or investment expenses. (5) "Property held for investment": (A) It includes (i) property producing income of a type described in section 469(e)(1), and (ii) an interest in a trade or business that (I) is not a passive activity, and (II) you do not materially participate in. (B) Expenses for property in (A)(i) are allocated the same way section 469 allocates them. (C) "Activity," "passive activity," and "materially participate" mean what section 469 says they mean. (e) Original issue discount (1) In general: The issuer of a debt instrument may deduct, for any tax year, the total of the daily portions of original issue discount (OID) for the days in that year. (2) Definitions and special rules: (A) "Debt instrument" means what section 1275(a)(1) says. (B) The daily OID portion is figured under section 1272(a) (ignoring paragraph (7) of that section and section 1273(a)(3)). (C) For a short-term obligation (as section 1283(a)(1)(A) defines it) whose issuer uses the cash method of accounting, OID — and any other interest on it — is deductible only when actually paid. (3) Special rule for OID held by a related foreign person: (A) If a related foreign person holds a debt instrument with OID, the issuer cannot deduct that OID until it is actually paid. This does not apply, though, if the OID is effectively connected with that foreign person's U.S. trade or business — unless a tax treaty makes the OID tax-exempt or taxed at a reduced rate. (B) If the related foreign holder is a controlled foreign corporation or a passive foreign investment company: (i) the issuer may deduct the OID before it is paid, but only up to the amount that, that same year, is included in the gross income of a U.S. person who owns stock in that corporation. (ii) The Secretary may exempt certain transactions by regulation, including ordinary-course transactions. (C) "Related foreign person" means someone who (i) is not a U.S. person, and (ii) is related to the issuer under section 267(b). (4) Exception: This subsection does not apply to a debt instrument described in section 1272(a)(2)(D) — loans between individuals. (5) Special rules for high-yield OID obligations: (A) For an "applicable high yield discount obligation" issued by a corporation: (i) no deduction is allowed for the "disqualified portion" of its OID; and (ii) the rest of the OID is not deductible until it is paid. Rules similar to those in (i)(3)(B) apply to figure the OID amount and when it counts as paid. (B) The "dividend equivalent portion" of the OID is treated, for purposes of the dividends-received deduction (sections 243, 245, 246, and 246A), as a dividend the issuing corporation paid. That dividend equivalent portion is the part of the OID that (I) comes from the disqualified portion, and (II) would have counted as a dividend if it had instead been a stock distribution. (C) The "disqualified portion" is the smaller of: (I) the total OID, or (II) the share of the instrument's total return that matches the ratio of its "disqualified yield" to its yield-to-maturity. "Disqualified yield" means the yield-to-maturity minus the sum described in subsection (i)(1)(B) plus 1 percentage point. "Total return" means what the OID would have been if certain interest described in section 1273(a)(2) had been included in the stated redemption price at maturity. (D) This paragraph does not apply to an obligation issued by a corporation for any period the corporation is an S corporation. (E) This paragraph does not affect how earnings and profits are figured, except that no reduction is made for the disqualified OID portion when figuring the dividend-equivalent amount. (F) Temporary suspension: This paragraph does not apply to a high-yield obligation issued between September 1, 2008 and December 31, 2009, if issued to exchange for non-high-yield debt from the same issuer — except this suspension does not cover certain treaty-described interest, or debt issued to a related person. Debt covered by this suspension is not treated as high-yield debt again if exchanged further. The Secretary may extend the suspension to later periods if the debt markets remain distressed. (G) See subsection (i) for the full definition of "applicable high yield discount obligation." (6) Cross references: See section 1288 for OID on tax-exempt obligations. See section 1275(b) for special rules for certain personal-use borrowers. (f) Denial of deduction for interest on certain obligations not in registered form (1) In general: No deduction is allowed for interest on a "registration-required obligation" unless the obligation is in registered form. (2) "Registration-required obligation" means any obligation — including one a government entity issues — except one that (i) a natural person issued, (ii) is not the type offered to the public, or (iii) matures within 1 year of issue. (B) The Secretary may, by regulation, cover obligations under (ii) or (iii) anyway, if they are a type frequently used to avoid federal taxes, applying only to obligations issued after the regulation takes effect. (3) Book-entry systems: Rules similar to section 149(a)(3) apply, and a dematerialized book-entry system, or another Secretary-approved book-entry system, counts as a qualifying book-entry system. (g) Reduction of deduction where section 25 credit taken If you were issued a mortgage credit certificate under section 25, your interest deduction under this section — for interest tied to that certificate — is reduced by the amount of credit you can claim under section 25 (figured without regard to section 26). (h) Disallowance of deduction for personal interest (1) In general: If you are not a corporation, you cannot deduct personal interest. (2) "Personal interest" means any interest that would otherwise be deductible under this chapter, except: (A) interest tied to a trade or business (not counting work as an employee); (B) investment interest, as subsection (d) defines it; (C) interest counted under section 469's passive-activity rules; (D) qualified residence interest, as defined below; (E) interest under section 6601 on unpaid estate tax during an approved extension under section 6163; and (F) student-loan interest deductible under section 221. (3) Qualified residence interest: (A) In general, it is interest paid or accrued during the year on (i) "acquisition indebtedness," or (ii) "home equity indebtedness," tied to a "qualified residence." Whether a property is a qualified residence is judged at the time the interest accrues. (B) "Acquisition indebtedness": (i) debt used to buy, build, or substantially improve a qualified residence, and secured by that residence — including debt from refinancing such debt, but only up to the amount refinanced. (ii) Cap: no more than $1,000,000 total ($500,000 for a married person filing separately). (C) "Home equity indebtedness": (i) debt (other than acquisition debt) secured by a qualified residence, up to (I) the residence's fair market value, minus (II) the acquisition debt on it. (ii) Cap: no more than $100,000 ($50,000 for a married person filing separately). (D) Debt from on or before October 13, 1987: (i) is treated as acquisition debt, without the $1,000,000 cap. (ii) Instead, the $1,000,000 cap on other acquisition debt is reduced — but not below zero — by the amount of outstanding pre-1987 debt. (iii) "Pre-October 13, 1987 indebtedness" means debt incurred by that date and secured by a qualified residence continuously since, or debt that refinances such debt without exceeding the refinanced amount. (iv) This special refinancing treatment stops once the original loan's term ends — or, if the loan does not amortize over its term, once the first refinancing's term ends, or 30 years after that refinancing, whichever comes first. (E) Mortgage insurance premiums treated as interest: (i) premiums for qualified mortgage insurance, tied to acquisition debt on a qualified residence, count as qualified residence interest. (ii) But this amount is reduced — not below zero — by 10 percent for every $1,000 (or part of $1,000) that your adjusted gross income exceeds $100,000 ($50,000 if married filing separately). (iii) This treatment does not apply to insurance contracts issued before January 1, 2007. (iv) It also does not apply at all to amounts paid or accrued after December 31, 2021, or allocable to any period after that date — this rule has ended. (F) Special rules for tax years after 2017: (i) For tax years beginning after December 31, 2017: home-equity indebtedness interest is not deductible; the acquisition-debt cap drops to $750,000 ($375,000 separate); the mortgage-insurance-as-interest rule does not apply; and the lower $750,000 cap does not apply to debt incurred on or before December 15, 2017 — though for debt incurred after that date, the cap is reduced by the amount of any pre-December-15-2017 debt still counted as acquisition debt. If you signed a binding written contract before December 15, 2017 to close on a home before January 1, 2018, and actually closed before April 1, 2018, use April 1, 2018 as the cutoff date instead. (ii) Refinancing after 2017: refinanced debt keeps its original incurrence date for the cap, up to the amount refinanced — but this stops once the original loan's term (or first refinancing's term, or 30 years after, whichever is first) ends. (iii) This provision is applied without regard to the debt-discharge income exclusion rule in section 108(h)(2). (4) Special rules for tax years 2025 through 2028, for qualified passenger vehicle loan interest: (A) For tax years beginning after December 31, 2024 and before January 1, 2029, "personal interest" does not include "qualified passenger vehicle loan interest." (B) That term means interest on debt taken out after December 31, 2024, to buy — and secured by a first lien on — an "applicable passenger vehicle" for personal use. It does not include interest on: fleet-sale loans; loans for non-personal commercial vehicles; lease financing; loans for salvage-title vehicles; or loans for vehicles meant for scrap or parts. You must include the vehicle's VIN on your tax return, or the interest does not qualify. (C) Limits: the interest counted cannot exceed $10,000 for the year. It is also reduced — not below zero — by $200 for every $1,000 (or part) that your modified adjusted gross income exceeds $100,000 ($200,000 on a joint return). "Modified adjusted gross income" means adjusted gross income plus amounts excluded under sections 911, 931, or 933. (D) "Applicable passenger vehicle" means a vehicle that: you are the first user of; is built mainly for public streets, roads, and highways (not a rail-only vehicle); has at least 2 wheels; is a car, minivan, van, SUV, pickup truck, or motorcycle; counts as a motor vehicle under title II of the Clean Air Act; and weighs under 14,000 pounds. It must also have had its final assembly happen within the United States. (E) "Final assembly" means the process of finishing the vehicle with all parts needed for it to run, whether or not those parts are permanently installed, at the plant that delivers it to a dealer. Refinanced car debt counts too, if secured the same way, up to the refinanced amount. This does not include debt owed to a related party under sections 267(b) or 707(b)(1). (5) Other definitions and special rules: (A) "Qualified residence" means (i) your main home (as section 121 defines it), plus (ii) one other home you pick for the year, used as a residence under section 280A(d)(1). If a married couple files separately, they are treated as one taxpayer, and each spouse gets to count one home — unless both consent in writing to let one spouse count both. A home you never rent out during the year can still count, despite section 280A(d)(1). (B) Debt secured by stock in a co-op housing corporation is treated as secured by the unit the taxpayer, as a tenant-stockholder, is entitled to occupy; if the stock legally cannot secure debt, the debt still counts as secured if the taxpayer shows it was used to buy that stock. (C) Debt does not stop being treated as "secured" just because a state or local homestead or debtor-protection law in effect on August 16, 1986 makes the security interest unenforceable or limits it. (D) For estates and trusts, a residence they hold counts as a qualified residence if the estate or trust shows it is a qualified residence of a beneficiary who has a present or residuary interest. (E) "Qualified mortgage insurance" means insurance from the Department of Veterans Affairs, the Federal Housing Administration, or the Rural Housing Service, plus private mortgage insurance as the Homeowners Protection Act of 1998 defines it. (F) Prepaid mortgage insurance premiums covering future periods must be capitalized and spread over those periods; no deduction is allowed for any unamortized balance if the mortgage is paid off early — except this rule does not apply to VA or Rural Housing Service insurance. (i) Applicable high yield discount obligation (1) In general: This term means a debt instrument where: (A) it matures more than 5 years after issue; (B) its yield to maturity is at least the applicable federal rate under section 1274(d) for the month of issue, plus 5 percentage points; and (C) it has "significant" original issue discount. The Secretary may, by regulation, allow a higher benchmark rate — either where a taxpayer shows it fits the same principles as the applicable federal rate, or temporarily, during distressed debt-market conditions. (2) "Significant original issue discount" exists if the amount that would be included in income before the close of an accrual period ending more than 5 years after issue is more than the sum of: (A) the interest actually scheduled to be paid by then, plus (B) the instrument's issue price times its yield to maturity. (3) Special assumptions for this test: (A) assume every payment happens on the last day allowed; (B) assume any payment made in the issuer's other obligations happens when it must be paid in cash or non-obligation property — and, except for testing the yield rate itself, "obligation" here also includes stock. (4) "Debt instrument" means what section 1275(a) defines it to mean. (5) The Secretary must write regulations to carry this subsection out, including: (A) adjustments for variable interest rates, options, indefinite maturities, contingent payments, assumed debts, or conversion rights; and (B) anti-avoidance rules covering issuers other than C corporations, borrowing arrangements, or similar setups. (j) Limitation on business interest (1) In general: The deduction for business interest in any tax year cannot exceed the sum of: (A) that year's business interest income, plus (B) 30 percent of that year's adjusted taxable income (never less than zero), plus (C) that year's floor plan financing interest. (2) Carryforward: Business interest disallowed under (1) is treated as business interest paid or accrued the next year. (3) Small-business exemption: This limit does not apply to a taxpayer (other than a barred tax shelter) that meets the gross-receipts test in section 448(c) for the year. A non-corporate, non-partnership taxpayer applies that test as if it were a corporation or partnership. (4) Partnerships: (A) This limit applies at the partnership level; the deduction is figured into the partnership's non-separately stated income or loss. A partner's own adjusted taxable income is figured without their distributive share of partnership items, but plus their distributive share of the partnership's "excess taxable income." (B) Disallowed partnership interest does not carry forward at the partnership level; instead, it is allocated to partners as "excess business interest." A partner treats their allocated excess business interest as their own business interest in the next year they get excess taxable income from that partnership — but only up to that excess taxable income; any leftover carries to later years. (iii) The partner's basis in the partnership goes down by the excess business interest allocated to them; if they later dispose of the interest, their basis goes back up by any part of that reduction that was never actually used as a deduction — but no deduction is allowed for that basis increase itself. (C) "Excess taxable income" is figured using a ratio tied to the partnership's adjusted taxable income and its interest income/expense. (D) Similar rules apply to S corporations and their shareholders. (5) "Business interest" means interest tied to a trade or business — not investment interest, and not interest capitalized under sections 263(g) or 263A(f). (6) "Business interest income" means interest income tied to a trade or business — not investment income. (7) "Trade or business" does not include: (i) working as an employee; (ii) an "electing real property trade or business"; (iii) an "electing farming business"; or (iv) selling or furnishing electricity, water, sewage disposal, or gas/steam through a local system or pipeline, if a government body or ratemaking authority sets the rates. (B) An "electing real property trade or business" is one described in section 469(c)(7)(C) that makes an irrevocable election under this paragraph. (C) An "electing farming business" is a farming business (as section 263A(e)(4) defines it), or certain agricultural cooperatives, that make an irrevocable election under this paragraph. (8) "Adjusted taxable income" means taxable income figured without: non-business income, gain, deduction, or loss items; business interest or business interest income itself; net operating loss deductions; section 199A deductions; depreciation, amortization, or depletion deductions; and certain foreign-income inclusions — plus any other adjustments the Secretary sets. (9) "Floor plan financing interest" means interest on debt used to finance motor vehicles — self-propelled vehicles, boats, or farm machinery and equipment, plus certain trailers and campers — held for sale or lease, and secured by that inventory. (10) Coordination with capitalization rules: The business-interest cap applies whether the interest would otherwise be deducted or capitalized. The allowed amount is applied first to interest that would have been capitalized, then to interest that would have been deducted. Interest carried forward under (2) is not treated as subject to capitalization rules later. (11) The Secretary must issue regulations or guidance to carry this subsection out. (12) Special rule for 2019 and 2020: (A) For tax years beginning in 2019 or 2020, the 30 percent figure in (1)(B) is generally raised to 50 percent — with special partnership timing rules, and an election to opt out. (B) For a tax year beginning in 2020, a taxpayer may elect to use their 2019 adjusted taxable income instead of the current year's, with a pro-rated version for short tax years. (13) Cross references: See section 168(g)(1)(F) for the depreciation-system rule for electing real property trades or businesses. See section 168(g)(1)(G) for the same rule for electing farming businesses. (k) Section 6166 interest No deduction is allowed under this section for interest under section 6601 on unpaid estate tax, for any period an extension under section 6166 is in effect. (l) Disallowance of deduction on certain debt instruments of corporations (1) In general: No deduction is allowed for interest paid or accrued on a "disqualified debt instrument." (2) A "disqualified debt instrument" is corporate debt payable in equity of the issuer or a related party, or in equity the issuer (or a related party) holds in someone else. (3) Debt counts as "payable in equity" only if: (A) a substantial amount of principal or interest must, or may at the issuer's or a related party's option, be paid in or converted into that equity; (B) a substantial amount of principal or interest must, or may, be pegged to that equity's value; or (C) the debt is part of an arrangement reasonably expected to lead to (A) or (B). If the holder (or a related party) has an option that could trigger this, and it is substantially certain to be exercised, that counts too. (4) If the equity involved belongs to someone other than the issuer or a related party, the basis of that equity goes up by the amount disallowed as a deduction under (1). (5) Exception: This does not cover debt a securities dealer (or related party) issues that is payable in equity — other than the issuer's or a related party's own equity — the dealer holds in its capacity as a securities dealer, as section 475 defines that term. (6) "Related party" follows the relationships described in section 267(b) or 707(b). (7) The Secretary must issue regulations to carry this out, including rules preventing avoidance through issuers that are not corporations. (m) Interest on unpaid taxes attributable to nondisclosed reportable transactions No deduction is allowed for interest under section 6601 on an underpayment, to the extent that underpayment comes from the part of a "reportable transaction understatement" (as section 6662A(b) defines it) for which the disclosure requirement in section 6664(d)(2)(A) was not met. (n) Cross references (1) See section 264 for the ban on deducting certain amounts paid for insurance, endowment, or annuity contracts. (2) See section 265(a)(2) for the ban on deducting interest tied to tax-exempt income. (3) See section 266 for the ban on deducting carrying charges chargeable to capital account. (4) See section 267 for the ban on deducting interest between related taxpayers. (5) See section 1055 for how redeemable ground rents and related real property are treated.