What Is IRS Code 168 and How Does It Impact Depreciation?

The IRS tax code includes provisions to help businesses manage asset costs over time. IRS Code 168 governs how certain property is depreciated for tax purposes, determining how quickly businesses can recover investments in tangible assets like machinery, equipment, and buildings. Proper application of these rules can reduce tax liability and improve cash flow.

Depreciation Methods

Depreciation allocates an asset’s cost over its useful life. IRS Code 168 outlines specific methods, the most common being the Modified Accelerated Cost Recovery System (MACRS), which allows larger deductions in an asset’s early years. This front-loaded approach reduces taxable income more significantly at the start.

MACRS includes the General Depreciation System (GDS) and the Alternative Depreciation System (ADS). GDS, the default, typically results in higher initial deductions using a declining balance method that switches to straight-line depreciation when advantageous. ADS spreads deductions evenly over a longer period and is required for certain property types or when elected by the taxpayer.

Under GDS, the declining balance method applies at either 200% or 150%, depending on the asset category. A five-year asset using the 200% declining balance method, for example, sees 40% of its remaining value deducted in the first year, 24% in the second, and so on, until switching to straight-line depreciation. This accelerates deductions, helping businesses offset high initial costs.

Property Classifications

The IRS assigns depreciable assets to different property classes, determining how long businesses can recover costs. Recovery periods range from three to 39 years based on asset type.

Personal property, such as office furniture, vehicles, and manufacturing equipment, generally has shorter recovery periods. Computers and peripheral equipment fall into the five-year category, while certain farming and construction machinery are assigned seven years. These shorter lifespans allow quicker deductions, reflecting typical wear and tear.

Real property, including buildings and permanent structures, follows longer depreciation timelines. Residential rental property is depreciated over 27.5 years, while nonresidential buildings, such as office complexes and retail spaces, have a 39-year recovery period. Land is not depreciable, but improvements like sidewalks, fences, and parking lots may qualify for 15-year depreciation.

Some property classifications have unique rules. Leasehold improvements, for example, often fall under a 15-year recovery period if they meet specific criteria, such as being made to an interior portion of a nonresidential building. Qualified restaurant and retail improvements may also be eligible for shorter depreciation schedules if they meet IRS guidelines.

Bonus Depreciation

Bonus depreciation allows businesses to immediately write off a significant portion of an asset’s cost, accelerating deductions and reducing taxable income more aggressively than standard methods.

Under current tax law, bonus depreciation has been decreasing from its peak of 100% in 2022. In 2024, the deduction is 60%, and it will continue declining by 20 percentage points each year until it reaches 0% in 2027 unless extended by Congress.

To qualify, property must have a recovery period of 20 years or less, including machinery, equipment, and certain leasehold improvements. Used property may also be eligible if it is new to the taxpayer and meets IRS requirements. Unlike Section 179 expensing, bonus depreciation has fewer restrictions on previously owned property.

Since the deduction applies when an asset is placed in service rather than when purchased, businesses must plan acquisitions carefully. For example, if a company buys equipment in December 2024 but does not install or use it until January 2025, the deduction applies to the 2025 tax year, potentially reducing its value as the bonus percentage declines. Timing purchases strategically can maximize tax savings.

Election Out of Certain Provisions

Businesses sometimes opt out of specific depreciation benefits to align with financial strategies, manage taxable income, or comply with regulatory requirements. The IRS allows elections that modify how depreciation deductions apply, affecting the timing of expense recognition and overall tax liability.

One common election is opting out of bonus depreciation, done on a class-by-class basis for eligible property. Businesses may choose this if they expect higher future tax rates, preferring to defer deductions to offset income in later years when they may be more valuable. This is particularly relevant for pass-through entities, such as S corporations and partnerships, where owners are taxed at individual rates that could change due to legislation or personal income levels.

Another election involves using the Alternative Depreciation System (ADS) instead of GDS. While ADS results in lower annual deductions due to longer recovery periods, it may be required for businesses operating internationally under the Tax Cuts and Jobs Act (TCJA) provisions related to the interest expense limitation under Section 163(j). Companies subject to these limitations must use ADS for certain assets, affecting depreciation schedules and financial planning.

Recapture Implications

Depreciation provides tax benefits, but when an asset is sold or disposed of, the IRS may require a portion of those benefits to be repaid through depreciation recapture. This ensures taxpayers do not receive excessive tax advantages by claiming deductions and then selling the asset at a gain.

For personal property, such as machinery and equipment, depreciation recapture falls under Section 1245 of the Internal Revenue Code. If a business sells an asset for more than its adjusted basis—original cost minus accumulated depreciation—the difference is taxed as ordinary income rather than capital gains. For example, if a company buys equipment for $50,000, claims $30,000 in depreciation, and sells it for $40,000, the $20,000 gain from depreciation is taxed at ordinary income rates, which can be as high as 37% for individuals. Any remaining gain beyond the recaptured depreciation is taxed at capital gains rates, which are generally lower.

Real property follows different recapture rules under Section 1250. Buildings and structures depreciated using straight-line methods are subject to a maximum recapture tax rate of 25% on the portion of the gain attributable to depreciation. If accelerated depreciation was used, the excess depreciation over straight-line amounts may be subject to additional recapture. This distinction is particularly relevant for commercial real estate investors who have used aggressive depreciation strategies.

Tax planning strategies, such as like-kind exchanges under Section 1031, can help defer or mitigate recapture liabilities when disposing of depreciated assets.