When Should Construction Loan Interest Be Capitalized Instead of Expensed?
Most development teams treat construction-loan interest the same way they treat rent or insurance premiums: it hits the P&L every month, and the banker reads the EBITDA that falls out. That habit is wrong under U.S. GAAP for qualifying projects, and it quietly misstates both the asset on the balance sheet and the earnings the lender is underwriting.
Interest is not always a period cost. For a real estate development that qualifies, it is part of the cost of getting the asset ready.
What ASC 835-20 actually requires
FASB’s interest-capitalization guidance (ASC 835-20) says the historical cost of an asset should include the financing cost incurred while that asset is being prepared for its intended use. The stated objective is straightforward: capitalize a cost that relates to acquiring a resource that will benefit future periods, and charge it against the periods those benefits show up.
Qualifying assets include assets constructed for an entity’s own use and assets intended for sale or lease that are produced as discrete projects. Real estate developments are the textbook example of that second category.
Interest capitalization begins only when three conditions are all present:
Expenditures for the asset have been made
Activities necessary to get the asset ready for its intended use are in progress
Interest cost is being incurred
“Activities” is construed broadly. It is not limited to pouring concrete. Preconstruction work such as plans, permitting, and site preparation counts. So do interruptions that are externally imposed or inherent in the development process. What does not count is intentional delay: if the sponsor parks the project, capitalization stops.
Capitalization ends when the asset is substantially complete and ready for its intended use. Occupancy is not the test. An office building that is finished and leasable is ready even if the lease-up is still underway.
How much interest goes into the asset
The amount capitalized is avoidable interest: the interest that would not have been incurred if the expenditures for the qualifying asset had not been made. In practice that means applying a capitalization rate to the weighted-average accumulated expenditures for the period.
If a specific construction loan is tied to the project, that rate applies to expenditures up to the loan balance. Expenditures above that amount use a weighted-average rate on the entity’s other borrowings. In every case, capitalized interest cannot exceed total interest cost incurred in the period.
Accumulated expenditures for this calculation are measured on a cash basis (unless an accrual itself bears interest). Progress billings received from customers reduce the expenditure base. That last point matters for for-sale projects and for any structure where buyer deposits or progress payments come in before completion.
Land is not a free pass
Buying dirt does not, by itself, turn interest into a capitalizable cost. Interest on debt used to purchase land is capitalized only while development activities are in progress. On a large assemblage, only the portion of the land actually under development qualifies. Tracts held for a later phase stay in holding-cost expense until that phase starts.
That rule is where many South Florida and multi-phase pro formas go soft. Sponsors capitalize interest across the whole land bank because “we’re developing the site.” GAAP asks a narrower question: which acres are actually undergoing activities right now?
Property taxes and insurance follow the same clock
ASC 970 (Real Estate — General) tells the same story for property taxes and insurance. Those holding costs are capitalized as project costs only during periods when activities necessary to get the property ready for its intended use are in progress — the same activity test used for interest. After the property is substantially complete and ready for use, taxes and insurance go back to the P&L as incurred.
So the three big “holding costs” — interest, real estate taxes, and insurance — share one capitalization window. Open it too early and you inflate the asset. Leave it open too late and you bury operating expense in construction-in-progress, which then flows into basis, depreciation, or cost of sales.
Why bankers and equity partners care
Expensing construction interest that should have been capitalized understates current earnings and understates the carrying amount of the project. Capitalizing interest past substantial completion does the opposite: it props up EBITDA while the asset is already earning (or should be). Either error shows up in DSCR covenants, investor waterfalls, and the development fee / promote math that assumes a clean project cost.
It also changes tax basis conversations. Capitalized interest becomes part of the depreciable (or inventory) basis of the asset. The book treatment under ASC 835-20 is not identical to every tax capitalization regime, but the two are close enough that a messy book schedule usually means a messy tax schedule.
A practical checklist for development CFOs
Map each project’s capitalization start and stop dates to the three ASC 835-20 conditions, not to the construction loan closing date alone.
Split multi-phase land so only active phases carry capitalized interest, taxes, and insurance.
Tie the capitalization rate to specific project debt first, then to a documented weighted-average rate on other borrowings.
Reconcile weighted-average expenditures to cash draws and equity contributions every month — not at certificate of occupancy.
Stop capitalization at substantial completion / ready-for-intended-use, even if lease-up or sell-out continues.
Keep the same stop date for property taxes and insurance under ASC 970-340.
If your WIP schedule tells the banker whether job profit is real, your interest-capitalization schedule tells them whether project cost is real. Both belong in the monthly package, not in a year-end cleanup.
Sources
FASB Accounting Standards Codification Topic 835-20, Interest — Capitalization of Interest (qualifying assets, capitalization period, and measurement), as summarized in PwC, Property, plant, equipment and other assets, §1.3 “Capitalized interest” (publication date Aug. 6, 2026): PwC capitalized interest guidance
ASC 835-20-15-5 and 835-20-15-6 (qualifying assets and assets for which interest is not capitalized); ASC 835-20-25-3 (three conditions to begin capitalization); ASC 835-20-30-2 through 30-6 (avoidable interest, capitalization rate, and ceiling).
FASB Accounting Standards Codification Topic 970, Real Estate — General, including ASC 970-340-25-8 (capitalization of property taxes and insurance during the same activity period used for interest). See also EY, Financial reporting developments: real estate project costs (updated guides discussing ASC 970 and the link to ASC 835-20): EY accounting guidance
Original FASB Statement No. 34, Capitalization of Interest Cost (Oct. 1979), the predecessor standard now codified in ASC 835-20.
Ultramar provides fractional CFO and controller support for real estate developers, contractors, and property operators. This post is for general information and is not accounting, tax, or legal advice.
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