Which Federal Depreciation Rules Does California Disallow?

Depreciation is an accounting method that allows a business to spread the cost of a tangible asset over its useful life. Both the Internal Revenue Service (IRS) and state governments establish tax regulations for depreciation. These federal and state rules are not always aligned, which can create differences in how a business calculates its taxable income for federal and state purposes. The variations require careful record-keeping to ensure the correct income is reported to each authority.

Key Federal Depreciation Rules California Disallows

California does not conform to two key federal depreciation provisions. The first is bonus depreciation, governed by Internal Revenue Code (IRC) Section 168(k). This federal rule permits businesses to deduct a percentage of the purchase price of new and used qualifying assets in the year they are placed in service. California law does not allow for this accelerated first-year depreciation deduction.

The second area of non-conformity involves the Section 179 expense deduction. Federally, this provision allows taxpayers to deduct the cost of certain qualifying property in the year it is placed in service, up to a specified limit. While California has its own version of the Section 179 deduction, its annual limits are lower than the federal ones. For the 2024 tax year, the federal maximum deduction is $1,220,000 with an investment limit of $3,050,000. In contrast, California’s limits remain lower at $25,000 and $200,000, respectively.

California’s Approach to Asset Depreciation

California’s conformity with the federal Modified Accelerated Cost Recovery System (MACRS) depends on the business entity type. For taxpayers under the Personal Income Tax Law—such as sole proprietorships, partnerships, LLCs, and S-corporations—California law generally aligns with the standard MACRS framework. This system depreciates the cost of tangible property over a predetermined period based on the asset’s class life, such as 5-year property (e.g., computers, office machinery) or 7-year property (e.g., office furniture, fixtures).

However, for businesses taxed under the Corporation Tax Law, primarily C-corporations, California does not conform to MACRS. These corporations must use alternative depreciation methods, such as the straight-line method, and follow asset lives specified in older federal revenue procedures. This approach results in a higher taxable income for the state in the initial years of an asset’s life.

Managing Depreciation Differences on Your Tax Return

Businesses must maintain two separate depreciation schedules: one for federal tax purposes and another for state tax purposes. These schedules should track key information for each asset, including:

• A detailed description
• The date it was placed in service
• Its original cost or basis
• The annual depreciation taken for federal purposes
• The annual depreciation allowed for California
• The cumulative difference between the two

This detailed tracking culminates in the completion of a specific state tax form, but the correct form depends on the business entity. Individuals and pass-through entities report the difference between federal and state depreciation on Form 3885A, Depreciation and Amortization Adjustments. The resulting adjustment from this form flows to Schedule CA (540) to modify the state’s taxable income.

C-corporations, however, must use a different form. They report their depreciation calculations on Form 3885, Corporation Depreciation and Amortization, which is then attached to Form 100, the California Corporation Franchise or Income Tax Return. You can find the most current versions of these forms and their instructions on the California Franchise Tax Board (FTB) website.