What Is a Depreciation Allowance and How Is It Calculated?

A depreciation allowance is the yearly tax deduction that lets a business recover the cost of physical property gradually, over the asset’s useful life, instead of writing off the full price the year of purchase. It matches the expense of a long-lived asset to the income that asset helps produce, reducing taxable income each year the property is in service. Calculating it comes down to four pieces of information about the asset and a choice of method, almost always the Modified Accelerated Cost Recovery System (MACRS) that the IRS has built into Publication 946.

What Property Qualifies

Internal Revenue Code Section 167 sets four tests. You must own the asset (or bear the economic risks and rewards of ownership), use it in a trade, business, or income-producing activity, have a determinable useful life for it, and expect it to last more than one year.¹

Machinery, delivery trucks, office furniture, computers, rental buildings, and commercial buildings all qualify. Land does not, because it doesn’t wear out. Neither does a personal vehicle you never use for business, a home you live in but don’t rent, or inventory held for sale to customers.

Listed Property

Some assets get extra scrutiny because they can easily slip into personal use: vehicles, computers used outside a regular business office, and cell phones. If business use of a listed asset drops to 50 percent or less, you have to switch from an accelerated method to straight-line going forward and recapture any excess deductions already claimed.² A contemporaneous log of business versus personal use is the only reliable defense if the IRS asks.

Passenger Vehicle Caps

Even when a car qualifies, the annual deduction is capped. For passenger automobiles placed in service in 2026, the first-year limit is $20,300 with bonus depreciation or $12,300 without it.³ These caps override the normal MACRS math, so a $60,000 sedan can’t be fully written off in year one even when bonus depreciation would otherwise permit it. Vehicles above 6,000 pounds gross vehicle weight sit outside the passenger-vehicle caps.

Information You Need Before the Math

Four numbers drive every calculation:

Cost basis: what you paid, including sales tax, shipping, and installation.⁴
Placed-in-service date: the date the asset was ready and available for its intended business use, which may not match the purchase date. This starts the depreciation clock.
Recovery period: the number of years the IRS assigns to that class of property, listed in Publication 946.⁵
Salvage value: expected worth at the end of useful life. MACRS ignores it; straight-line outside MACRS still uses it.

An error in any one of these figures follows the asset for years, which is why most accountants keep a dedicated ledger with each item’s basis, in-service date, and running depreciation.

Recovery Periods by Asset Class

Under the General Depreciation System (GDS), which covers most business property, assets fall into these classes:

5-year property: cars, light trucks, computers, office machinery, research equipment
7-year property: office furniture, filing cabinets, agricultural machinery
15-year property: land improvements such as fences, roads, and landscaping
27.5-year property: residential rental buildings
39-year property: nonresidential commercial buildings, including offices, warehouses, and retail stores

The Alternative Depreciation System (ADS) assigns longer recovery periods and is mandatory in a few situations, such as property used predominantly outside the United States. GDS is the default for most domestic small businesses and produces the bigger deduction.⁵

How the Deduction Is Calculated

Straight-Line Method

The simplest approach spreads the cost evenly. Subtract salvage value from cost basis, then divide by useful life. Equipment costing $50,000 with $5,000 salvage value and a 10-year life produces a $4,500 deduction every year.⁵ Planning is easy; early-year deductions are smaller than with an accelerated method.

MACRS Declining Balance

MACRS front-loads deductions into the early years, when the purchase is still being paid off. For 5-year, 7-year, and 10-year property, it starts with a 200-percent declining balance rate and automatically switches to straight-line in whichever year that switch produces a bigger deduction. Longer-lived farm property and certain utility property use a 150-percent declining balance rate. Salvage value is ignored entirely, which simplifies the arithmetic and increases total early deductions.⁵

Half-Year and Mid-Quarter Conventions

MACRS does not assume a full first year of use. Under the default half-year convention, property placed in service during the year is treated as placed in service at the midpoint, giving half a year’s deduction in both the first and last recovery years. One catch: if more than 40 percent of the year’s depreciable property (excluding real estate) goes into service during the last three months, the mid-quarter convention applies instead and assigns a smaller first-year deduction to those late-year purchases.⁶ Real property uses a mid-month convention.

Section 179 Immediate Expensing

Section 179 lets you deduct the full cost of qualifying property in the year it is placed in service rather than spreading the cost across the recovery period. Eligible property includes tangible equipment and machinery, off-the-shelf software, and certain qualified real property improvements to nonresidential buildings such as roofs, HVAC, fire protection, and security systems.⁷

The deduction has an annual dollar ceiling that adjusts for inflation. For 2025 the maximum was $1,250,000, with a phase-out beginning when total qualifying property placed in service exceeded $3,130,000. The One Big Beautiful Bill Act roughly doubled the base amounts, so the 2026 figures will be significantly higher once the IRS publishes the inflation-adjusted revenue procedure. One rule that does not move: the Section 179 deduction cannot exceed taxable income from active business operations for the year, though any unused amount carries forward.

Bonus Depreciation

Bonus depreciation, formally the “additional first year depreciation deduction” under IRC Section 168(k), lets you write off a large percentage of an asset’s cost in the first year on top of normal MACRS depreciation. The percentage had been phasing down from 100 percent in 2022 to 80, 60, and 40 percent. Property placed in service in 2026 that was acquired before January 20, 2025 falls under the old schedule and receives only a 20-percent first-year bonus.

The One Big Beautiful Bill Act (P.L. 119-21) changed this. For qualified property acquired after January 19, 2025, 100-percent bonus depreciation is permanently restored with no phase-down or expiration.⁸ Most new equipment, machinery, and vehicles bought and placed in service in 2026 can be fully expensed in year one. A reduced 40-percent bonus can be elected for the first tax year ending after January 19, 2025, if full expensing would create an unwanted loss.

Acquisition date matters. Equipment placed under a binding contract in December 2024 but placed in service in 2026 still gets only 20 percent. The same equipment purchased in February 2025 qualifies for the full 100 percent.

Where the Deduction Goes on the Return

You report depreciation on Form 4562, Depreciation and Amortization, which covers new assets placed in service during the year, Section 179 elections, and listed property.⁹ From there the deduction flows to the return that matches your business form: Schedule C for sole proprietors, Schedule E for rental property, Form 1065 for partnerships, Form 1120 for corporations.¹⁰

If your only depreciable assets went into service in prior years, you generally do not need a new Form 4562 to keep claiming the annual deduction; the ongoing amount appears on the appropriate schedule. The form comes back in any year you place new depreciable property in service, claim Section 179, or report listed property.

If You Forgot to Claim Depreciation

Missing depreciation on an eligible asset is common, and the IRS does not let you fix it with an amended return. File Form 3115, Application for Change in Accounting Method, to move from the impermissible method (no depreciation) to the correct one. Under the automatic change procedures there is no user fee, and all the missed depreciation is recovered through a single Section 481(a) adjustment in the year of change instead of amending prior years one by one.¹¹ Attach the original unsigned Form 3115 to your timely filed return for the year of change and send a signed copy to the IRS National Office by the same deadline. The catch-up can produce a substantial one-time deduction.

Recapture When You Sell

Every year of depreciation reduces the asset’s tax basis. Sell the property later for more than that reduced basis, and the IRS recaptures part of the gain at rates above the standard capital gains rate.

For personal property such as equipment, vehicles, and machinery (Section 1245 property), any gain attributable to prior depreciation is taxed as ordinary income.¹² A $100,000 machine depreciated to a $30,000 basis and sold for $80,000 produces a $50,000 gain taxed at ordinary rates. Aggressive first-year expensing under Section 179 or bonus depreciation can create a surprise tax bill years later on sale.

For depreciable real property such as commercial buildings (Section 1250 property), the rules are gentler. The portion of gain tied to depreciation, called unrecaptured Section 1250 gain, is taxed at a maximum rate of 25 percent. Any remaining gain above original cost basis is taxed at the regular long-term capital gains rate of 0 to 20 percent.¹³ Both types of sale are reported on Form 4797.²

Records You Have to Keep

The usual three-year rule for tax records does not apply to depreciable property. You have to keep records for each asset until the statute of limitations expires for the tax year in which you dispose of it.¹⁴¹⁵ For a building depreciated over 39 years and then sold, that means holding onto purchase documents, improvement receipts, and depreciation schedules for more than four decades. Discarding them after three years can leave you unable to prove your basis on sale, exposing the entire sale price to tax. If depreciation deductions cannot be substantiated in an audit, the IRS can disallow them, and the accuracy-related penalty on the resulting underpayment is 20 percent of the shortfall.¹⁶

1
Office of the Law Revision Counsel. 26 USC 167 – Depreciation
2
Internal Revenue Service. About Form 4797, Sales of Business Property
3
Internal Revenue Service. Revenue Procedure 2026-15 Depreciation Limitations for Passenger Automobiles Placed in Service During Calendar Year 2026
4
Internal Revenue Service. Publication 551 (12/2025), Basis of Assets
5
Internal Revenue Service. Publication 946 (2025), How To Depreciate Property
6
eCFR. 26 CFR 1.168(d)-1 – Applicable Conventions, Half-Year and Mid-Quarter Conventions
7
Internal Revenue Service. Depreciation Expense Helps Business Owners Keep More Money
8
Internal Revenue Service. Treasury, IRS Issue Guidance on the Additional First Year Depreciation Deduction Amended as Part of the One Big Beautiful Bill
9
Internal Revenue Service. About Form 4562, Depreciation and Amortization (Including Information on Listed Property)
10
Internal Revenue Service. Instructions for Form 4562 (2025)
11
Internal Revenue Service. Instructions for Form 3115
12
Office of the Law Revision Counsel. 26 USC 1245 – Gain From Dispositions of Certain Depreciable Property
13
Internal Revenue Service. Topic No. 409, Capital Gains and Losses
14
Internal Revenue Service. Topic No. 305, Recordkeeping
15
Internal Revenue Service. How Long Should I Keep Records
16
Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments