Does Virginia Allow Section 179 Depreciation?

Virginia allows businesses to claim a depreciation deduction under Section 179 of the Internal Revenue Code (IRC), mirroring federal provisions. However, the state does not conform to the federal bonus depreciation rules found in IRC Section 168(k). While a business might take a large upfront deduction on its federal return combining Section 179 and bonus depreciation, the Virginia return will require an adjustment.

Any federal deduction for bonus depreciation must be disallowed on the Virginia tax return. This non-conformity creates an ongoing administrative task for businesses with assets in Virginia, requiring specific adjustments each year until the asset is fully depreciated or sold.

Virginia’s Conformity with Federal Depreciation Rules

Virginia consistently makes an exception for depreciation and does not allow the federal bonus depreciation deduction. This legislative choice means the state deliberately decouples from the accelerated depreciation benefits offered by the federal government.

For federal purposes, a business might expense a portion of an asset’s cost under Section 179 and then apply bonus depreciation to the remaining basis. For Virginia tax purposes, only the Section 179 portion of that deduction is initially allowed. The bonus depreciation amount must be added back to income, creating a difference in taxable income between the federal and state returns in the year an asset is placed in service.

Calculating the Virginia Depreciation Adjustment

First, the taxpayer must compute an “add-back” to their Virginia income. This add-back is equal to the full amount of the bonus depreciation claimed for an asset on the federal tax return for that year. This step effectively cancels out the federal bonus depreciation deduction for state tax purposes, increasing the taxpayer’s Virginia taxable income in the initial year.

Following the add-back, the taxpayer can then calculate a Virginia-specific subtraction. This subtraction allows the business to recover the cost of the asset over time according to a different schedule. The allowable Virginia depreciation is calculated as if bonus depreciation was never claimed, using the standard Modified Accelerated Cost Recovery System (MACRS) depreciation method on the asset’s full basis.

For example, assume a business places a $150,000 piece of equipment in service and takes a $50,000 Section 179 deduction and the remaining $100,000 as 100% bonus depreciation on its federal return. For Virginia purposes, the business would first add back the $100,000 bonus depreciation. Then, it would calculate the normal MACRS depreciation on that $100,000 basis (e.g., 20% for a 5-year asset in the first year, resulting in a $20,000 deduction), which it would take as a subtraction. The net effect in year one is a Virginia income increase of $80,000 compared to the federal return.

Reporting Depreciation Adjustments on Virginia Tax Forms

The net depreciation adjustment must be reported on the appropriate Virginia income tax forms, and the specific form depends on the business structure. For pass-through entities like S corporations and partnerships, these adjustments are reported on Schedule 502 ADJ, which accompanies the main Form 502. For corporations filing a Form 500, the Virginia corporate income tax return, these adjustments are made directly on the form or an accompanying schedule.

The information from Schedule 502 ADJ for pass-through entities is then passed through to the individual owners or partners via their Virginia Schedule VK-1. This ensures that the individual owners report their pro-rata share of the depreciation adjustments on their personal Virginia income tax returns.

State Tax Implications of Selling Depreciated Assets

Because Virginia disallows bonus depreciation, the amount of depreciation deducted over the life of an asset will be lower for state purposes compared to federal purposes in the initial years. This results in the asset having a higher adjusted basis for Virginia than it does for federal tax calculations. When the asset is eventually sold, this difference in basis leads to a different calculation for the taxable gain or loss on the disposition.

For federal purposes, the gain or loss is calculated by subtracting the lower federal adjusted basis from the sales price. For Virginia purposes, the gain or loss is calculated using the higher Virginia adjusted basis, resulting in a smaller gain or a larger loss for Virginia tax purposes. This discrepancy requires another adjustment on the Virginia tax return in the year of the sale to account for the smaller gain or larger loss attributable to the Virginia basis calculation.