How Tax Depreciation Works: Methods, Section 179, and Recapture

Tax depreciation is how the IRS lets you deduct the cost of business property over time instead of writing off the entire purchase in one year. For most tangible assets, the deduction is spread across a fixed recovery period under the Modified Accelerated Cost Recovery System (MACRS). Two provisions, Section 179 and bonus depreciation, can compress that recovery into a single year for qualifying property. And when you eventually sell the asset, recapture rules pull some of the tax benefit back. Here is how tax depreciation works from purchase through sale.

What You Can Depreciate

Four conditions must all be true. You need a depreciable interest in the property, which the IRS treats as ownership for tax purposes. You must use it in a business or income-producing activity. It must have a determinable useful life, meaning it wears out, decays, becomes obsolete, or loses value. And it must be expected to last more than one year.¹

Leased property is a frequent point of confusion. If you lease equipment or space from someone else, you generally cannot depreciate it because the owner holds the depreciable interest. The narrow exception is a lease structured so that you carry the real burdens and benefits of ownership, but that is unusual and fact-specific.²

Several categories are always excluded. Land never depreciates because it doesn’t wear out or become obsolete. Inventory held for sale to customers is handled through cost-of-goods-sold accounting, not depreciation. Property still under construction doesn’t start depreciating until it is placed in service, meaning ready and available for its intended use.³

Figuring Your Depreciable Basis

Basis is the starting number for every depreciation calculation. For purchased property, it equals the total cost, which is more than the sticker price. Sales tax, freight, installation, testing, excise taxes, and legal fees that must be capitalized all fold into basis.⁴

Converting personal property to business use follows a different rule. The depreciable basis is the lesser of the fair market value on the date of conversion or your adjusted basis on that date. If your old personal laptop was worth $600 when you started using it for business but you originally paid $1,200, your depreciable basis is $600.⁵

Under MACRS, salvage value is treated as zero. You do not estimate what the asset will be worth at the end of its useful life, which simplifies the math compared to older systems.

Recovery Periods by Property Class

The IRS assigns every depreciable asset to a property class, and each class has a fixed recovery period that determines how many years your deduction is spread across. The main classes come from Section 168 of the Internal Revenue Code.⁶

3-year property: certain specialized tools, over-the-road tractor units, and horses over a certain age.
5-year property: computers, office machinery, vehicles, and research equipment.
7-year property: office furniture, fixtures, and most general-purpose equipment without a shorter class.
15-year property: land improvements such as fences, roads, and parking lots, plus qualified improvement property.
27.5-year property: residential rental buildings.
39-year property: nonresidential real property like offices, retail stores, and warehouses.

Qualified improvement property is worth knowing about if you renovate. Interior improvements to a nonresidential building you own or lease fall into the 15-year class rather than 39-year. A $200,000 office renovation recovers more than twice as fast when properly classified. The improvements must be interior and cannot include building expansion, elevators or escalators, or changes to the internal structural framework.⁶

If you are not sure where an asset fits, Publication 946 includes class-life tables covering hundreds of specific asset types.

How the Deduction Is Spread Across Those Years

MACRS uses three depreciation methods, and the property class determines which one applies.

The 200% declining balance method is the default for 3-, 5-, 7-, and 10-year property. It front-loads deductions by applying a rate double the straight-line rate to the remaining unrecovered balance each year, then automatically switches to straight-line in the year that produces a larger deduction.⁶

The 150% declining balance method applies to 15- and 20-year property. Same mechanics, smaller multiplier, smaller early-year deductions, and the same switch to straight-line when that produces a better result.

Straight-line divides cost evenly across the recovery period. It is mandatory for residential rental and nonresidential real property. You can also elect it for any other class if you prefer level deductions, but the election is binding for the entire class placed in service that year.

The Alternative Depreciation System (ADS) is a required substitute in specific situations, including tangible property used predominantly outside the United States, tax-exempt bond-financed property, and listed property used 50% or less for business. ADS uses straight-line and longer recovery periods, which means smaller annual deductions. Under ADS, residential rental stretches to 30 years and nonresidential real property to 40 years.⁷

When Depreciation Starts and Stops

Conventions decide what portion of the first and last year to count, since assets are rarely bought on January 1 or sold on December 31.

Half-year convention: the default for most personal property. The asset is treated as placed in service at the midpoint of the year, so you get half a year in year one and half in the final year.
Mid-quarter convention: triggered when more than 40% of your total depreciable property for the year is placed in service during the last three months. It prevents loading up on December purchases and still claiming six months of depreciation.
Mid-month convention: applies to all real property. The asset is treated as placed in service at the midpoint of the month you actually placed it in service.

You do not choose the convention. The property type and the timing of your year’s purchases determine it.⁸

Section 179: Expensing the Full Cost in Year One

Section 179 lets you deduct the full purchase price of qualifying business equipment in the year you place it in service instead of spreading it across the recovery period. For 2026, the maximum deduction is approximately $2.56 million (adjusted annually for inflation from a $2.5 million base), and it phases out dollar-for-dollar once total qualifying purchases exceed roughly $4.09 million.⁹

There is an income limitation. Your Section 179 deduction cannot exceed your total taxable income from the active conduct of any trade or business. If you have $100,000 in business taxable income and buy $150,000 of equipment, you can deduct $100,000 this year and carry the unused $50,000 forward.

Section 179 covers tangible personal property such as machinery, equipment, and off-the-shelf software. It also covers certain improvements to nonresidential real property, including roofs, HVAC, fire protection, alarm, and security systems. Land and buildings themselves do not qualify.

One trap: not every state conforms to the federal Section 179 limits. Some cap the deduction much lower or require a partial add-back on the state return. Check state rules before planning around a large write-off.

Bonus Depreciation

Bonus depreciation is a separate first-year deduction that stacks with regular MACRS. The One Big Beautiful Bill Act, signed in July 2025, permanently restored 100% bonus depreciation for qualified property acquired after January 19, 2025.¹⁰

For property placed in service during 2026, you can deduct 100% of the cost in year one. Bonus depreciation applies to new property and, in most cases, used property, as long as it is new to you. Unlike Section 179, there is no dollar cap and no taxable-income limitation, and you can use bonus depreciation to create or increase a net operating loss.

Timing matters. Property under a written binding contract signed before January 20, 2025, may not qualify for the restored 100% rate and could be stuck with lower phaseout percentages that were in effect before the new law. If you bought equipment under a contract signed in late 2024 but placed it in service in 2026, verify the acquisition date rules with a tax professional.

The De Minimis Safe Harbor for Small Purchases

Not every asset is worth tracking on a depreciation schedule. The de minimis safe harbor election lets you expense tangible property costing $2,500 or less per item or per invoice in the year of purchase, skipping depreciation entirely. If your business has an applicable financial statement (a certified audited statement), the threshold rises to $5,000 per item.¹¹

To use the safe harbor, you need a written accounting policy in place at the start of the tax year stating that you expense items below the threshold, and you make the election annually on your timely filed return.

Vehicles and Other Listed Property

Vehicles and certain other assets the IRS considers prone to personal use are “listed property,” and they carry two restrictions ordinary equipment does not.

The 50% Business Use Threshold

Listed property must be used more than 50% for business to qualify for accelerated MACRS methods or a Section 179 deduction. At 50% or less, you must use ADS straight-line and cannot claim Section 179. The IRS requires substantiation, such as a mileage log for a vehicle.¹²

If you claimed accelerated depreciation in earlier years and business use later drops to 50% or below, you must recapture the excess. The IRS calculates the difference between what you actually deducted and what you would have deducted under ADS and adds that amount to your income in the year business use fell.

Annual Dollar Caps on Passenger Vehicles

Even with 100% bonus depreciation available, passenger automobiles, trucks, and vans have annual depreciation caps. For vehicles placed in service during 2026:¹³

With bonus depreciation: $20,300 in year 1, $19,800 in year 2, $11,900 in year 3, and $7,160 each year after.

Without bonus depreciation (you elected out or the vehicle does not qualify): $12,300 in year 1, then the same $19,800, $11,900, and $7,160 schedule.

These caps mean a $60,000 vehicle cannot be fully depreciated in year one. The unrecovered cost continues at $7,160 per year until fully deducted. Vehicles with a gross vehicle weight rating over 6,000 pounds are exempt from these caps, which is why heavy SUVs and trucks are sometimes marketed as tax-advantaged purchases.

Depreciation Recapture When You Sell

Depreciation lowers your taxable income while you own the asset, but the IRS reclaims some of that benefit when you sell at a gain. This is depreciation recapture, and failing to plan for it is one of the more expensive tax surprises for business owners and rental investors.

For depreciable equipment, machinery, vehicles, and other personal property, Section 1245 treats gain as ordinary income up to the total depreciation you claimed or were allowed to claim. Only gain above the original cost gets long-term capital gain treatment. Most used equipment sells for less than original cost, so the entire gain typically ends up taxed at ordinary rates.¹⁴

Real estate follows a different rule. When you sell a depreciated building at a gain, the portion of the gain attributable to depreciation is taxed at a maximum rate of 25% (unrecaptured Section 1250 gain), and any remaining gain above your original cost is taxed at the applicable long-term capital gains rate.¹⁵

Sales of depreciable business property are reported on Form 4797.¹⁶

Reporting Depreciation and Keeping Records

All depreciation deductions run through Form 4562. You enter the depreciable basis, the recovery period, the convention, and the method for each asset placed in service during the year; assets carried from prior years are totaled on a single line.¹⁷

The total flows to whichever return applies to your business. Sole proprietors carry it to Schedule C. S corporations and partnerships report it on Form 1120-S or Form 1065 and pass it through on Schedule K-1. C corporations report it on Form 1120.¹⁸

You only need to file Form 4562 in years when you place new property in service, claim Section 179, claim bonus depreciation, or report depreciation on listed property. If you are simply continuing straight-line depreciation on existing assets and none of those triggers apply, the depreciation amount goes straight onto your return.

The general three-year records rule¹⁹ is not enough for depreciable property. You need records to compute depreciation every year, and for listed property the IRS requires records for as long as recapture can still occur, which covers the entire recovery period.²⁰ Keep the purchase invoice, proof of the date placed in service, the method and recovery period, and business-use records for every asset until at least three years after you file the return for the year you dispose of it or finish depreciating it. Losing the documentation lets the IRS disallow the deduction outright.

1
Internal Revenue Service. Publication 946 – How To Depreciate Property – Section: What Property Can Be Depreciated
2
Internal Revenue Service. Publication 946 – How To Depreciate Property – Section: Leased Property
3
Internal Revenue Service. Publication 946 – How To Depreciate Property – Section: Placed in Service
4
Internal Revenue Service. Publication 551 – Basis of Assets – Section: Cost Basis
5
Internal Revenue Service. Publication 551 – Basis of Assets – Section: Property Changed to Business or Rental Use
6
Office of the Law Revision Counsel. 26 USC 168 – Accelerated Cost Recovery System
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Internal Revenue Service. Publication 946 – How To Depreciate Property – Section: Required Use of ADS
8
Internal Revenue Service. Publication 946 – How To Depreciate Property
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Office of the Law Revision Counsel. 26 USC 179 – Election To Expense Certain Depreciable Business Assets
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Internal Revenue Service. Treasury, IRS Issue Guidance on the Additional First Year Depreciation Deduction Amended as Part of the One Big Beautiful Bill
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Internal Revenue Service. Tangible Property Final Regulations
12
Office of the Law Revision Counsel. 26 USC 280F – Limitation on Depreciation for Luxury Automobiles
13
Internal Revenue Service. Rev. Proc. 2026-15
14
Office of the Law Revision Counsel. 26 USC 1245 – Gain From Dispositions of Certain Depreciable Property
15
Internal Revenue Service. Treasury Decision 8836 – Unrecaptured Section 1250 Gain
16
Internal Revenue Service. Instructions for Form 4797
17
Internal Revenue Service. Form 4562 – Depreciation and Amortization
18
Internal Revenue Service. Instructions for Form 4562 – Depreciation and Amortization
19
Internal Revenue Service. How Long Should I Keep Records
20
Internal Revenue Service. Publication 946 – How To Depreciate Property – Section: Listed Property