The home home affairs department was allocated Â£2.8m to construct a 20-cell facility to replace the existing 40-year-old block at Lord Street station.
Lord Street is one of three police stations to close in the next year due to cuts within the constabulary budget.
A Manx government spokesman said building work was scheduled for completion by March 2015.
Home Affairs Minister Juan Watterson said: "For a number of years we have been detaining people in conditions that are unfit for the purpose, that are not safe enough for officers or detainees to be kept in.
"It must not be forgotten that detainees are innocent until proven guilty."
Building work has begun on a new multi-million pound custody block at Police Headquarters in Douglas.