What Is Arizona-Only Depreciation and How It Works

Arizona-only depreciation is a separate state-level depreciation calculation Arizona requires whenever a business claims federal bonus depreciation on an asset. Because Arizona does not automatically adopt every change Congress makes to the Internal Revenue Code, you add back the federal depreciation on affected assets on your state return and subtract the amount Arizona actually allows. You do this every year the asset is in service, not just the first year.¹

Why Arizona Makes You Recalculate

Arizona starts its individual and corporate income tax from federal adjusted gross income, but it does not accept every federal deduction as filed. The friction point is bonus depreciation under IRC Section 168(k), which lets a business write off a large share of an asset’s cost in the first year rather than spreading it across the asset’s useful life. Arizona’s statutes reference the Internal Revenue Code, but any new federal tax change requires the Arizona legislature to pass a separate conformity bill before it applies for state purposes.²

To bridge the mismatch, state law requires taxpayers to add back the total federal depreciation claimed on affected assets and then take a separate subtraction for the amount Arizona allows.³ The total deduction over the life of the asset ends up the same. The timing is what differs, and timing matters for cash flow.

How the Annual Add-Back and Subtraction Works

Every year you own an affected asset, your Arizona return carries two adjustments. On Arizona Form 140, Line 17, you enter the total federal depreciation deducted on your federal return for the year. That addition erases the federal number from the state calculation.⁴

On Line 26 you enter the depreciation Arizona allows for that year. For assets placed in service after 2016, Arizona computes this subtraction as the depreciation allowable under IRC Section 167(a), calculated as though the additional bonus depreciation equaled the full amount permitted under IRC Section 168(k).⁵ When Arizona’s version of Section 168(k) matches the federal version, the two lines cancel out. When they diverge, the subtraction is smaller than the addition in the early years, which pushes Arizona taxable income up.

In later years the math usually flips. Federal depreciation has slowed down because the big write-off already happened, while Arizona is still allowing a regular annual deduction. The subtraction then exceeds the addition and your Arizona taxable income drops. Across the full life of the asset the adjustments wash to zero.

A Simple Example

Say you buy a $100,000 machine in a year when federal law allows 100% bonus depreciation and Arizona recognizes only 20% bonus. Federally, you deduct the full $100,000 in year one. On Arizona:

Year 1: You add back the $100,000 of federal depreciation. Arizona allows a subtraction based on 20% bonus ($20,000) plus regular MACRS depreciation on the remaining $80,000 of basis. The subtraction is much smaller than the addition, so Arizona taxable income rises.
Years 2 through 5 or so: You add back whatever federal depreciation remains, which is often zero because you already took it all. Arizona keeps allowing MACRS deductions on the $80,000 portion. The subtraction now exceeds the addition each year, reducing Arizona taxable income.

The AZDOR’s own examples in Tax Procedure ITP 16-2 follow this pattern: both additions and subtractions appear in every year, and the balance between them shifts as the two schedules play out at different speeds.¹

The 2026 Wrinkle: 100% Federal Bonus Is Back

The One Big Beautiful Bill Act permanently restored 100% first-year bonus depreciation for qualifying property acquired and placed in service after January 19, 2025. Federal bonus had been phasing down from 100% in 2022 toward a scheduled 20% in 2026 and zero in 2027. That phase-down was quietly shrinking the gap between federal and Arizona depreciation, which made the state adjustment less painful each year.

The gap is now wide open again. Because Arizona does not automatically conform to new federal tax changes, the state legislature would need to pass a separate bill referencing the new law for the restored 100% bonus to flow through to Arizona returns.² Until that happens, your federal return may claim a full immediate write-off while your Arizona return computes the subtraction using an older, lower bonus percentage. The result is a large first-year add-back and a multi-year trail of subtractions on the state side.

The same conformity question applies to Section 179 expensing, where federal law now allows a maximum deduction of roughly $2.5 million, up from the prior $1.25 million cap. Arizona would need to conform separately for the higher limit to apply on the state return.² Check the Arizona Department of Revenue’s conformity page before filing, since the legislature may act at any point during the year.

Corporate Returns Follow the Same Pattern

Corporations run the adjustments under a parallel pair of statutes. The addition for total federal depreciation falls under A.R.S. Section 43-1121, paragraph 4, which requires corporations to add back “the amount of any depreciation allowance allowed pursuant to section 167(a) of the internal revenue code to the extent not previously added.”⁶

The matching subtraction sits in A.R.S. Section 43-1122, paragraph 5, which allows the corporation to subtract depreciation allowed under IRC Section 167(a) to the extent it has not already reduced Arizona taxable income.⁷ Add back federal depreciation, subtract Arizona-allowable depreciation, and reconcile what remains when the asset is sold. Arizona’s corporate income tax rate drops to 2.45% for taxable years beginning after December 31, 2025, so the dollar impact per asset is relatively modest, but businesses with large capital expenditures will still feel the timing shift.

Selling or Disposing of the Asset

When you sell, scrap, or otherwise dispose of an asset that has carried the Arizona adjustment, you need a final reconciliation. The two depreciation schedules ran at different speeds, so your Arizona adjusted basis in the asset is typically higher than your federal adjusted basis. A higher basis means a smaller taxable gain, or a larger deductible loss, at the state level.

Arizona law provides a specific subtraction for this. On Form 140, Line 36 (reported as Item K), you may subtract the amount of depreciation allowed under the Internal Revenue Code that has not yet reduced your Arizona taxable income in the current or prior years.⁴ The individual rule sits at A.R.S. Section 43-1022, paragraph 18, and the corporate version at A.R.S. Section 43-1122, paragraph 5.⁵

By the time the asset leaves your books, Arizona has allowed the same total cost recovery as the federal return. The AZDOR’s published procedure describes this as giving “the taxpayer the same basis for Arizona purposes as for federal purposes when the asset is sold or otherwise disposed.”¹ Skip that final subtraction and you overpay Arizona tax on the sale. Most people never notice.

Record-Keeping You Have to Maintain

Dual depreciation schedules are where this process breaks down for most taxpayers. For every affected asset you need two running accumulated depreciation totals: one tracking what you claimed federally and one tracking what Arizona allowed. The difference between those totals drives every annual adjustment and the final disposition number.

The IRS tells you to keep property records until the statute of limitations expires for the year you dispose of the asset.⁸ In practice that means holding on to the purchase documents, both depreciation schedules, and every Arizona return showing the annual adjustments for as long as you own the asset, plus at least three years after disposal. If you received the asset in a tax-free exchange, keep the records from the original property too, because your basis carries over.

Tax software handles some of this on its own, but only if you set up the Arizona depreciation override correctly in the first year. Miss the setup and the software applies the federal numbers to the state return. You lose the adjustments you were entitled to in every later year, and reconstructing parallel schedules years later during an audit is a mess worth avoiding at the start.

What Happens If You Get It Wrong

Errors cut both ways. Forget the add-back and you understate Arizona income and underpay state tax. Forget the subtraction and you overpay. Arizona’s individual income tax rate is currently 2.5%, so the dollar amount per asset may look small, but it compounds across multiple assets and multiple years.⁹

On the federal side, a substantial understatement of income tax triggers a 20% accuracy-related penalty under IRC Section 6662.¹⁰ Arizona imposes its own penalties and interest on state underpayments. The more common risk, though, is quieter: overpaying Arizona tax year after year by missing the subtraction, with no notice from the state to warn you.

1
Arizona Department of Revenue. Arizona Individual Income Tax Procedure ITP 16-2
2
Joint Legislative Budget Committee. 2025 Federal Budget Reconciliation Bill – Tax Conformity
3
Arizona Legislature. Arizona Code 43-1021 – Additions to Arizona Gross Income
4
Arizona Department of Revenue. Arizona Form 140 Booklet
5
Arizona Legislature. Arizona Code 43-1022 – Subtractions from Arizona Adjusted Gross Income
6
Arizona Legislature. Arizona Code 43-1121 – Additions to Arizona Gross Income for Corporations
7
Arizona Legislature. Arizona Code 43-1122 – Subtractions from Arizona Gross Income for Corporations
8
Internal Revenue Service. How Long Should I Keep Records
9
Arizona Department of Revenue. Individual Income Tax Highlights
10
Office of the Law Revision Counsel. United States Code Title 26 – 6662 Imposition of Accuracy-Related Penalty on Underpayments