Section 168 of the Internal Revenue Code sets the rules for depreciating business property under the Modified Accelerated Cost Recovery System (MACRS). It tells you three things for every asset you place in service: how many years you have to recover the cost, which method distributes the deductions across those years, and which averaging convention controls the first and last year. Get those three right, decide whether to layer in bonus depreciation or Section 179, and the yearly deduction follows.1Office of the Law Revision Counsel. 26 U.S. Code 168 – Accelerated Cost Recovery System
What Property Qualifies
Depreciation under Section 168 applies to property used in a trade or business or held for income production, with a determinable useful life longer than one year, that wears out or becomes obsolete. Land, inventory, and personal-use assets are out. Everything else falls into one of three groups.
Real property is buildings and permanent structures. Residential rental property, where at least 80% of gross rental income comes from dwelling units, is depreciated over 27.5 years. Nonresidential real property runs 39 years. Land itself is never depreciable, but improvements such as parking lots, fences, and sidewalks can land in the 15-year class.
Qualified improvement property (QIP) is a separate category worth knowing. It covers interior improvements to a nonresidential building made after the building is already in service, and excludes enlargements, elevators, escalators, and changes to the internal structural framework. QIP carries a 15-year recovery period and qualifies for bonus depreciation.1Office of the Law Revision Counsel. 26 U.S. Code 168 – Accelerated Cost Recovery System
Tangible personal property covers equipment, machinery, furniture, vehicles, and tools. If you use an asset for both business and personal purposes, only the business-use percentage is depreciable, and you need records showing how you arrived at the split.2Internal Revenue Service. Topic No. 704, Depreciation
Listed property is a watched subset of tangible personal property. Passenger automobiles are the common example. (The Tax Cuts and Jobs Act removed computers from the listed category in 2017.) Accelerated depreciation on listed property requires business use above 50%. If business use drops to 50% or below, you lose the accelerated methods and switch to straight-line under the longer Alternative Depreciation System (ADS) recovery period.
Passenger vehicles face a hard annual cap on depreciation on top of everything else. For vehicles placed in service in 2026, the first-year limit is $20,300 with bonus depreciation or $12,300 without it. The second-year cap is $19,800, the third year $11,900, and each year after that $7,160.3Internal Revenue Service. Rev. Proc. 2026-15 – Depreciation Limitations for Passenger Automobiles You calculate depreciation under the normal rules first, then compare it to the cap.
MACRS Recovery Periods by Class
Rather than asking each business to estimate how long an asset will last, MACRS assigns standardized recovery periods. Tangible personal property is slotted into classes of 3, 5, 7, 10, 15, or 20 years. Real property is either 27.5 years or 39 years.
- 3-year property: certain manufacturing tools, racehorses over two years old, and assets with an ADR midpoint of four years or less.
- 5-year property: computers, peripheral equipment, automobiles, light trucks, office machinery, and most research equipment.
- 7-year property: office furniture, fixtures, agricultural machinery, and any tangible personal property not assigned to another class.
- 15-year property: land improvements (fences, roads, sidewalks, landscaping), qualified improvement property, and certain utility property.
- 20-year property: farm buildings and municipal sewers placed in service after 2017.
The seven-year class is the default bucket. If an asset doesn’t clearly belong elsewhere, it ends up here. The IRS spells out the assignments in Revenue Procedure 87-56 and Publication 946. A cost segregation study on a building often finds that components (electrical systems, specialized flooring, certain fixtures) belong in 5-, 7-, or 15-year classes rather than the 39-year building class, which pulls deductions forward significantly.
Methods: Declining Balance and Straight-Line
Most tangible personal property defaults to the 200% declining balance method. The system doubles the straight-line rate and applies it to the asset’s remaining undepreciated balance each year. A five-year asset gets a 40% rate against a shrinking balance, producing large deductions early that taper off. MACRS automatically switches to straight-line in the year that produces a larger deduction so the full cost is recovered by the end of the period.
Property in the 15-year and 20-year classes uses the slightly less front-loaded 150% declining balance method. Real property, and any property depreciated under ADS, uses straight-line. Straight-line is also available as an election for any other class. The predictable even deductions are easier to forecast but smaller in the early years when cash flow matters most. The election goes one direction only: once you choose straight-line for a class in a given year, you cannot switch back.
Averaging Conventions
MACRS doesn’t track the exact date an asset went into service. Conventions standardize that date and decide how much depreciation lands in the first and last years.
- The half-year convention is the default for tangible personal property. It treats every asset as placed in service at the midpoint of the year, so you get half a year of depreciation in year one and half a year in the final year.
- The mid-quarter convention is mandatory when more than 40% of the total basis of personal property placed in service during the year is added in the last three months. Assets are treated as placed in service at the midpoint of the quarter they were actually acquired, which usually shrinks first-year deductions on late purchases. Real property is excluded from the 40% calculation.4eCFR. 26 CFR 1.168(d)-1 – Half-Year and Mid-Quarter Conventions
- The mid-month convention is required for all real property. It treats the asset as placed in service in the middle of the month it was actually placed in service.
The mid-quarter rule catches businesses that load up on equipment in December. Buy a $200,000 machine in March and a $500,000 machine in November, and the November purchase exceeds 40% of the total basis for the year, forcing the mid-quarter convention on every piece of personal property placed in service that year. Timing matters.
100% Bonus Depreciation After 2025
Bonus depreciation under Section 168(k) lets you write off the full cost of qualifying property in the year it enters service rather than spreading it over the recovery period. As of 2026, qualifying property is eligible for 100% bonus depreciation with no dollar cap. The One Big Beautiful Bill Act, signed in 2025, permanently restored the 100% rate for qualifying property acquired after January 19, 2025, and removed the scheduled phase-down that had been in place under the 2017 law. There is no sunset date.
To qualify, property must have a MACRS recovery period of 20 years or less. That covers most equipment, machinery, computers, vehicles (subject to the passenger auto caps), and qualified improvement property. Property depreciated under ADS does not qualify.
Used property is eligible, not just new. To qualify, you cannot have used the property before acquiring it, you cannot buy it from a related party, and your cost basis cannot be determined by reference to the seller’s basis.5Internal Revenue Service. Additional First Year Depreciation Deduction (Bonus) – FAQ Property inherited from a decedent does not qualify. Buying used equipment from an unrelated seller at fair market value works; receiving depreciated equipment as a gift from a family member’s business does not.
Anti-churning rules block businesses from recycling deductions by moving property between related parties. If you acquire property from a related party or in a transaction where your basis carries over from the seller, the property is ineligible for accelerated depreciation. These rules apply at the entity level for partnerships and S corporations.
Section 179 Compared to Bonus Depreciation
Section 179 also allows immediate expensing, but on different terms.6Office of the Law Revision Counsel. 26 U.S. Code 179 – Election to Expense Certain Depreciable Business Assets
- Section 179 has an annual maximum deduction (set at $1,000,000 by statute and adjusted for inflation), and the deduction phases out dollar-for-dollar once total qualifying property placed in service exceeds a threshold (set at $2,500,000 by statute, also inflation-adjusted). Bonus depreciation has no dollar cap.
- The Section 179 deduction cannot exceed taxable income from active trades or businesses, so it cannot create or increase a net operating loss. Bonus depreciation can.7Office of the Law Revision Counsel. 26 U.S. Code 172 – Net Operating Loss Deduction
- Section 179 is an election made property by property. Bonus depreciation applies automatically to all qualifying property unless you elect out.
- Section 179 reaches certain real property improvements (roofs, HVAC, fire protection, and security systems for nonresidential buildings). Bonus depreciation reaches QIP more broadly.
Many businesses use both. Section 179 is applied first, then bonus depreciation handles any remaining depreciable basis.
Elections and Why They Are Irrevocable
Section 168 elections apply to all property in the same class placed in service during the same tax year. You cannot cherry-pick individual assets inside a class, and the choice generally cannot be undone.
You can elect out of bonus depreciation. A business expecting lower income in future years might want deductions later rather than now. The election must be made on a timely filed return, including extensions, and applies class-wide.
You can elect ADS, which uses straight-line over generally longer recovery periods. Some taxpayers are required to use ADS, including those with tax-exempt bond financing, certain farming operations that elected out of the business interest limitation, and property used predominantly outside the United States.
You can also elect straight-line while keeping the standard MACRS recovery periods, which gives slower deductions than declining balance but faster than ADS. All of these elections are irrevocable for the assets they cover, so the upfront analysis is worth doing properly.
Recapture When You Sell
Every dollar of depreciation reduces your basis in the asset. When you sell, more of the price becomes gain, and recapture decides how that gain is taxed.
For tangible personal property, Section 1245 treats gain as ordinary income to the extent of all depreciation previously claimed.8Office of the Law Revision Counsel. 26 U.S. Code 1245 – Gain From Dispositions of Certain Depreciable Property Buy equipment for $100,000, claim $60,000 in depreciation, sell for $80,000: the $40,000 gain is entirely ordinary income because it sits within the $60,000 of prior depreciation.
Real property follows Section 1250. Buildings depreciated using the straight-line method (which is mandatory for real property under current law) are generally not subject to Section 1250 recapture, but the portion of the gain attributable to depreciation (unrecaptured Section 1250 gain) is taxed at a maximum rate of 25%, higher than the long-term capital gains rate on the remainder.
Two tools defer the hit. A like-kind exchange under Section 1031 lets you swap one piece of real property for another of similar nature and defer both gain and recapture.9Office of the Law Revision Counsel. 26 U.S. Code 1031 – Exchange of Real Property Held for Productive Use or Investment Since 2018, Section 1031 covers real property only; equipment and vehicles no longer qualify.10Internal Revenue Service. Like-Kind Exchanges – Real Estate Tax Tips An installment sale under Section 453 spreads gain recognition across the years payments arrive.
Fixing Past Depreciation Errors
If you’ve been using the wrong recovery period, the wrong method, or missed claiming depreciation altogether, you do not fix it by amending prior returns. The IRS treats it as a change in accounting method, filed on Form 3115.11Internal Revenue Service. Instructions for Form 3115, Application for Change in Accounting Method
The correction runs through a Section 481(a) adjustment, a one-time catch-up for the cumulative difference between what you deducted and what you should have. Underclaimed depreciation becomes a deduction in the year you file Form 3115. Overclaimed depreciation gets added back. Most depreciation corrections qualify for automatic consent, meaning no IRS pre-approval and no user fee.
This matters most after a cost segregation study reclassifies building components into shorter recovery periods. A business that has been writing off an entire building over 39 years may find that 20% to 30% of the cost belonged in 5-, 7-, or 15-year classes. The Section 481(a) adjustment captures all the missed accelerated depreciation in a single year, with no amended returns required.