Completion of the work and hotel opening is expected by late 2018.
The Grade A-listed castle will become Killeavy Hotel and Wellness Centre.
In addition to 40 boutique bedrooms, the hotel will also include meeting space both in the castle as well as in a planned permanent marquee adjacent to the castle for special events.
The now derelict former walled garden on the estate will also be restored to contain a café, with nature treks and walks in the nearby Slieve Gullion Forest Park.
Killeavy Castle Estate is set in a 330-acre estate on the Ballintemple Road in South Armagh.