Capitalized Interest Funds: How to Invest Them and Offset Costs

A capitalized interest fund is invested by matching the fund's maturities to the interest payment dates the fund exists to pay, so cash lands in the account as each payment comes due and the balance in between stays invested.

It is one of the funds that hold bond proceeds, and the payments it exists to make are the interest payments due on the securities for the period the set-aside covers, fixed by the bond's terms.

That fixed calendar is what drives everything on this page, from the maturity schedule to the tax treatment to the two structures built around it.

What capitalized interest is and why it is funded

Capitalized interest is a portion of the proceeds of an issue set aside to pay interest on the securities for a specified period, which is the MSRB glossary's definition, and the glossary notes it is also called funded interest.

The glossary adds that it is commonly used during construction of a revenue-producing project, so that debt service does not begin until the project is expected to be operating.

Where a revenue project also funds construction, that spending runs through the construction fund, and the capitalized interest fund pays the bondholders until the project is expected to be operating.

Why this matters for investing is that the fund has a defined job with a known last payment date, and that combination is what makes maturity matching possible.

Matching maturities to interest payment dates

The fund is invested by placing a maturity on each interest payment date inside the capitalization period, sized to the payment due that day, so principal arrives exactly when the payment must be made.

GFOA lists a typical investment horizon for a capitalized interest fund of 6 to 18 months, one of the typical ranges it publishes by fund type, and it presents these as typical ranges rather than rules.

The same GFOA guidance says expectations vary and that issuers should consult their advisory team and investment policy, and it recommends keeping the investment duration no longer than the expected drawdown schedule and revisiting the draw schedule periodically.

For this fund the draws are the interest payments themselves, which is why structures built around dated payouts fit it: a structured Treasury portfolio matched to payment dates places a maturity on each date the fund pays out.

Balances that must be available between payment dates or on short notice are a separate piece: Treasury's Demand Deposit SLGS are one-day certificates of indebtedness that roll over automatically each day until redemption is requested, under 31 CFR 344.7(a).

Their rate is an adjustment of the average yield at the most recent 13-week Treasury bill auction, interest accrues daily and compounds, and a negative rate resets to zero.

How reinvestment earnings can reduce the amount to borrow

Earnings the fund produces between its deposit and each payment date add to the money available to make that payment, which in arithmetic terms reduces the principal that must be set aside at the start for the fund to end at zero after the last payment.

Because the set-aside is a portion of the issue's proceeds, sizing it is a borrowing decision as well as an investing one.

In the illustration above, if a fund sized to end at zero after the last payment earned $75,000 over the 18 months, it would need $2,925,000 of principal at the start rather than $3,000,000 to cover the three payments; that is illustrative arithmetic, not a forecast, and what a particular fund earns depends on rates and on the structure chosen.

Once debt service does begin, the MSRB glossary defines coverage as the ratio of revenues available annually for debt service to the annual debt service requirement, and indentures define which revenues count as available differently.

How earnings on reinvested proceeds interact with coverage ratios is taken up on reinvestment earnings and coverage.

Temporary-period treatment

Capitalized interest is a portion of an issue's proceeds, and the temporary-period rules run on proceeds of an issue, so which period applies turns on how the proceeds are classified.

Proceeds of an issue that are reasonably expected to be allocated to working capital expenditures within 13 months after the issue date qualify for a temporary period of 13 months beginning on the issue date, under Treasury Regulation §1.148-2(e)(3)(i).

The classification is not automatic: capitalized interest can be treated as part of the capital project in some cases, which the regulation reaches through its cross-reference to the capital-project temporary period in §1.148-2(e)(2), and that call belongs to bond counsel.

The full set of periods, from the 3-year capital projects period to the 30-day windows, is the subject of the temporary periods page.

A separate federal rule bears on the investment's length: under section 149(g) of the Internal Revenue Code, as summarized in IRS Publication 4079, a bond is a hedge bond unless the issuer reasonably expects that 85 percent of spendable proceeds will be used within 3 years and that no more than 50 percent of proceeds is invested in nonpurpose investments whose yield is substantially guaranteed for 4 years or more.

Whether a particular instrument's yield is substantially guaranteed for those purposes is a tax-law determination, and it is one reason the length of a fixed-rate investment in this fund is raised with tax counsel.

Fixed-schedule GIC vs Treasury strip ladder

Two structures take a known payment calendar as their input: a guaranteed investment contract with withdrawals scheduled on the interest payment dates, and a ladder of Treasury STRIPS maturing on those dates.

The MSRB glossary's general definition of a guaranteed investment contract is an investment secured by a contract with a financial institution that guarantees a fixed rate of return and a fixed maturity, and bond-proceeds GICs often carry flexible draw schedules rather than one fixed maturity.

For arbitrage purposes, Treasury Regulation §1.148-1(b) reads the term more broadly: a guaranteed investment contract includes any nonpurpose investment with specifically negotiated withdrawal or reinvestment provisions and a specifically negotiated interest rate, and the definition also reaches agreements to supply investments on two or more future dates, such as a forward supply contract.

On the securities side, TreasuryDirect explains that STRIPS split a fixed-principal Treasury note, bond or TIPS into separate zero-coupon pieces, each paying once at maturity, under 31 CFR 356.31.

Bills and floating rate notes cannot be stripped, the minimum face amount to strip is $100 in $100 multiples, stripping and reassembly happen only in the commercial book-entry system rather than TreasuryDirect, and a 10-year bond becomes 21 pieces.

The MSRB glossary describes STRIPS as having the economic and trading characteristics of a zero coupon bond, which is the property that lets a single piece be matched to a single payment date.

Withdrawal provisions on a GIC, including what a capitalized interest fund would need before drawing early, are the subject of the withdrawals page.

When a GIC covering the capitalization period runs long enough to be a multi-year fixed-rate investment, the hedge-bond test above is one reason its length and its share of issue proceeds get raised with tax counsel.

The broader tradeoffs between the two forms for bond proceeds generally are compared on the GIC vs Treasury ladder page; for this fund the calendar, not preference, drives the shape of either one.

Which structure fits a particular issue turns on the fund's size, the payment schedule and the issue's tax posture, and that determination belongs to the issuer with its bond counsel and tax counsel.

mGIC, an independent, SEC-registered municipal advisor, evaluates and competitively bids guaranteed investment contracts, full-flex repurchase agreements and structured Treasury portfolios for funds like this one, and sells none of them.

Its Bidding Agent work covers the bid specifications, the solicitation of qualified providers, the questions between bid and award, and the comparison of bids on rate and non-rate terms, and its fee is paid by the winning provider rather than the issuer, at or below the safe-harbor maximum in the Treasury arbitrage regulations, and disclosed.

For a fund already invested, mGIC's free reinvestment review reads the fund's terms against its payment schedule and permitted investments, and it begins with a no-obligation conversation.

Final determinations about an issue's tax classification, permitted investments and required documentation belong to bond counsel and tax counsel.

Last updated 2026-10-06.

This page is general educational information about municipal finance and federal and state rules as of the date shown. It is not legal, tax or investment advice, and it is not a recommendation about any particular investment. Product availability, legality and suitability depend on the issuer, jurisdiction, governing documents and transaction-specific facts. Final legal and tax determinations remain with the issuer's bond counsel, tax counsel and other advisors.