What Is Depreciation and How Does Section 179 Work?

Depreciation is the tax and accounting system's way of spreading the cost of a business asset over its useful life. Instead of deducting the full cost of a piece of equipment in the year you buy it, you deduct a portion each year until the asset is fully written off.

The federal system that governs how fast you can depreciate assets is called MACRS. Two additional rules, Section 179 and bonus depreciation, let qualifying businesses deduct more of the cost upfront. Understanding all three matters because California doesn't fully follow federal rules, which means your federal and California tax returns will often show different income.

How MACRS Works

MACRS (Modified Accelerated Cost Recovery System) is the standard IRS depreciation system. Every business asset is assigned to a recovery period class that determines how many years you spread the deduction.

Common Recovery Period Classes

MACRS uses a declining balance method, your deductions are front-loaded, with larger deductions in the early years and smaller ones later. The method automatically switches to straight-line depreciation when that produces a larger deduction.

Half-year convention: Like the Canadian CCA system, MACRS applies a half-year convention in the first year, you get only half a year's deduction regardless of when you actually bought the asset.

Example: $10,000 piece of equipment (7-year property):

The IRS publishes full MACRS tables in Publication 946.

Section 179 Expensing

Section 179 lets you deduct the full cost of qualifying property in the year of purchase rather than spreading it over the recovery period.

2024 federal limits:

• Maximum deduction: $1,220,000
• Phase-out threshold: deduction reduces dollar-for-dollar when total asset purchases exceed $3,050,000
• Cannot create a loss, the Section 179 deduction is limited to your business taxable income

Qualifying property includes:

• Most tangible personal property used in business (equipment, computers, machinery)
• Business vehicles (subject to additional limits for passenger autos)
• Off-the-shelf software

California does not conform to federal Section 179 limits. California's Section 179 deduction is capped at $25,000, with a phase-out beginning at $200,000 in total purchases. If you buy $200,000 in equipment and take the full federal Section 179 deduction, your federal taxable income drops significantly, but your California taxable income stays much higher. Your NCO advisor reconciles this difference at tax time.

Bonus Depreciation

Bonus depreciation is a separate mechanism that allows immediate expensing of a percentage of qualifying property in the year of purchase. Unlike Section 179, it can create a loss.

Bonus depreciation percentages by year:

Bonus depreciation is being phased out under current law. Congress has discussed extending it, but as of now the scheduled phase-down stands.

California does not conform to bonus depreciation at all. California requires businesses to use standard MACRS depreciation, with no bonus percentage. This creates another federal/California gap: a business that takes significant bonus depreciation on the federal return will show higher California income.

The Federal vs. California Gap: Why It Matters

If you buy $200,000 in equipment in 2024:

This gap is normal, it just means your federal and California tax liability won't mirror each other in equipment-heavy years. Your NCO advisor tracks these differences and accounts for them at tax time.

What You Need to Do

Your job is straightforward: make sure every asset purchase is recorded in your books with the correct amount, date, and description. Your NCO advisor handles:

• Assigning the correct MACRS class
• Deciding how much Section 179 to take (based on your income picture)
• Applying bonus depreciation where beneficial
• Reconciling the federal vs. California differences

FAQ

Do I choose between MACRS, Section 179, and bonus depreciation?

Your NCO advisor makes that call based on your income and tax strategy. Often they're combined, Section 179 may cover part of a purchase, bonus depreciation covers more, and regular MACRS handles the rest.

Does depreciation apply to land?

No. Land cannot be depreciated because it doesn't wear out. Only the building and improvements on the land are depreciable.

What happens when I sell a depreciated asset?

When you sell an asset, you may trigger depreciation recapture, the IRS taxes back the depreciation deductions you previously took, at ordinary income rates (up to 25% for real property). Your NCO advisor will calculate this as part of the sale.

Does California ever give me a break on depreciation?

California allows the same MACRS rates as federal, just without Section 179 over $25,000 and without bonus depreciation. Over the full life of an asset, you'll deduct the same total amount; California just spreads it out more slowly.

Is depreciation optional?

For Section 179 and bonus depreciation, yes, you can elect out. For MACRS, the IRS requires you to claim the allowable depreciation (or reduce your asset's basis as if you did). Your NCO advisor will advise on whether electing out of accelerated deductions makes sense for your situation.