The One Big Beautiful Bill Act of 2025 introduced important ordering rules that affect how capitalized interest interacts with the Section 163(j) business interest limitation. These rules are particularly relevant for real estate developers, construction businesses, manufacturers, and other capital‑intensive operations.
What Is Capitalized Interest?
Capitalized interest is interest expense that is not immediately deductible but instead is added to the tax basis of an asset. This commonly occurs during the construction or production of long‑term assets such as buildings, facilities, or certain equipment.
Ordering Rules Under Section 163(j)
For taxable years starting in 2026, the Section 163(j) limitation must be applied before most interest capitalization provisions. Capitalized interest is treated as paid or accrued first when determining the amount of interest subject to the Section 163(j) limitation.
Practical Impact
If a taxpayer incurs both capitalized and currently deductible interest in a year, the capitalized portion is tested first under Section 163(j). If total interest exceeds the allowable limitation, the excess is disallowed and carried forward — even if it otherwise would have been capitalized into asset basis.
Capitalized Interest Example
Assume a business incurs $100,000 of total interest expense, of which $40,000 is capitalized and $60,000 is otherwise currently deductible. If Section 163(j) allows only $70,000 of interest, the $40,000 of capitalized interest is tested first, $30,000 of current interest is allowed, and the remaining $30,000 is disallowed and carried forward.
Planning Considerations
These rules make it critical for businesses to model Section 163(j) limitations before assuming interest can be capitalized. Taxpayers should carefully track disallowed interest carryforwards and consider the impact on project financing and long‑term cash flow.