State Conformity to Federal Bonus Depreciation

A federal deduction does not automatically become a state deduction. States decide how much of the federal rules they follow. For cost segregation, the difference can change the value of a study, sometimes materially.

The basic idea

Each state that has an income tax decides whether it conforms to federal depreciation rules. Conformity can be full, partial, or absent, and can be tied to a particular date. Many states have historically not conformed to federal bonus depreciation, while some do. The rules change over time, so check the current position for the state where the property is located and the state where you file.

What non-conformity typically means

If a state does not allow bonus depreciation, you generally add back the bonus amount on the state return and depreciate the assets under state rules, often using regular MACRS recovery periods. The add-back can mean that the state benefit of the first-year deduction is smaller than the federal benefit. The study's reclassification into 5, 7, and 15 year classes may still speed up state depreciation relative to 27.5 or 39 years, because regular accelerated methods can be allowed even without bonus.

Why this matters for the decision

Suppose the federal benefit is large but the state tax rate is high and the state does not conform. The net benefit needs to account for the difference. Conversely, a state that conforms increases the benefit. In a decision analysis, model federal and state effects separately.

Multiple states

If you own property in one state and live in another, you may have to file in both. The property state generally taxes income from the property. The resident state may tax all income with a credit for taxes paid elsewhere. The interaction with depreciation can be complex. Ask your preparer.

Passive and loss limits at the state level

States may have their own treatment of losses and passive activity rules, or follow federal rules. Some states limit loss carryforwards. Confirm.

Method changes and state filings

A federal method change may require state consideration. Some states require you to report the adjustment differently. Ask your preparer whether the state requires anything additional.

Basis differences

Where a state does not conform, your state basis in the property can differ from your federal basis. Your preparer must track both, which adds complexity. When you sell, gain can differ between federal and state returns. See Depreciation Recapture on Sale: What Comes Back.

Entities and composite returns

Partnership and S corporation owners may face composite or withholding requirements in some states. Check.

What to ask

• Does my state follow federal bonus depreciation?
• Does my state allow Section 179 up to the federal amounts? See Section 179 Versus Bonus Depreciation for the Study Decision.
• How is the catch-up adjustment treated?
• Does my state have any separate limits?

Keeping records

Track federal and state depreciation schedules. See Form 4562 and Reporting Basics After a Study.

Planning around differences

If your state does not conform and your state tax rate is high, ask your preparer to show the net benefit after state effects. In some cases the state effect is small. In others, it is enough to change the answer. Either way, better to know before you order the study.

Moving between states

If you move, your residence state changes, but the property state stays the same, and the interaction of the two can change. Tell your preparer when you move so that depreciation and any credits for taxes paid to other states are handled correctly.

Illustrative effect in words

Imagine two owners with identical properties and identical federal deductions. One lives and files in a state that follows federal bonus depreciation, and the other in a state that does not. The first owner's state return reflects the large first-year deduction. The second owner's state return adds back the bonus amount and takes depreciation over the regular schedule. The second owner still gets a state benefit from the reclassification, since regular accelerated depreciation applies to shorter classes, but the first-year state deduction is smaller. If the state tax rate is high, the difference can be notable.

Where to find the answer

Your preparer should know your state's position. State revenue departments publish guidance on depreciation, and instructions for state returns describe required adjustments. Because states change their positions, ask for the current rule and the tax year to which it applies.

Keeping separate schedules

Where states do not conform, your preparer will keep separate federal and state depreciation schedules. Ask for both. When you sell, the state gain can differ from the federal gain because of the difference in basis. Keep the schedules with your records so the sale computation is right.

What to avoid assuming

Do not assume your state follows federal rules just because a neighboring state does. Do not assume a prior year's treatment continues. Do not assume that a state with no income tax on individuals has no relevant rules for entities, since some jurisdictions tax entities differently. Ask specifically.

Next steps

If the state effect changes the result, update your model. See Cost Versus Benefit Without Guarantees.