When Should You Elect Out of Bonus Depreciation?

TL;DR: Electing out of bonus depreciation means telling the IRS you do not want the 100 percent first-year write-off on a class of property. It sounds like refusing free money, and most years it would be. But a deduction you cannot use this year is worth less than the same deduction spread across years when you can use it, and a few situations turn the big number into the worse trade. The election is made one class of property at a time, on a return filed by the due date, and undoing it later is harder than most owners expect.

Key Takeaways

• Bonus depreciation is automatic. You receive it unless you affirmatively elect out under Internal Revenue Code Section 168(k)(7).
• The election covers an entire class of property for an entire tax year. You cannot elect out on one appliance and keep it on another if both are five-year property placed in service the same year.
• You make it by attaching a statement to Form 4562 by the due date of the return, including extensions.
• Missed the election or want to undo it? You get one automatic six-month window if you filed on time. After that it takes a private letter ruling. Form 3115 cannot fix it.
• A big deduction can crowd out tax credits. Credits only offset tax you actually owe, so wiping out your tax bill can strand them as carryforwards.
• Electing out does not solve a passive loss problem. It changes when the deduction shows up, not whether you are allowed to use it.

What does electing out of bonus depreciation actually mean?

Bonus depreciation is not something you claim. It is something you receive by default, and Section 168(k)(7) is the door marked no thanks.

The statute is short. If a taxpayer elects out "with respect to any class of property for any taxable year," then bonus depreciation "shall not apply to any qualified property in such class placed in service during such taxable year." The IRS says the same thing in plainer words in its bonus depreciation FAQ, last reviewed May 12, 2026: "A taxpayer may elect out of the additional first year depreciation for the taxable year the property is placed in service. If the election is made, it applies to all qualified property that is in the same class of property and placed in service by the taxpayer in the same taxable year."

Class of property is the part people miss. A cost segregation study on a building typically produces three buckets: five-year personal property, seven-year property, and fifteen-year land improvements. Those are three separate classes, and you decide separately for each one. You can take full bonus on the fifteen-year land improvements and elect out of the five-year property in the same year on the same building. What you cannot do is pick and choose inside a class.

Elect out and the property does not disappear from your return. It simply depreciates on its normal schedule, a piece at a time, the way depreciation worked before bonus existed. That schedule is still front-loaded. The Instructions for Form 4562 (2025) say the method is "the 200% declining balance method" for 3-, 5-, 7-, and 10-year property and "the 150% declining balance method" for 15- and 20-year property. Under the usual half-year convention, five-year property still recovers 71.2 percent of its cost in the first three years. Electing out slows the deduction down. Most of it still shows up early.

Why would you turn down a 100 percent deduction?

Because the deduction is only worth what it actually offsets.

Here is the shape of the problem. A large first-year deduction can be bigger than the income you have to put it against. When that happens the excess does not vanish, but it does change character, and the version you get back later is worth less than the version you gave up.

Say you buy a rental for $900,000, with $700,000 allocated to the building after land. An engineering-based cost segregation study moves $180,000 of that basis into five, seven, and fifteen-year property. With 100 percent bonus depreciation, that entire $180,000 is deductible in year one.

Now suppose your income that year is modest, and the $180,000 is more than all of it. The leftover becomes a net operating loss, carried to future years.

High earners hit the same wall from the other side. Section 461(l) caps how much net business loss a noncorporate taxpayer can use against wages and other nonbusiness income in one year. For 2026 the cap is $256,000, or $512,000 on a joint return, and I covered why it dropped in the excess business loss limitation in 2026. Anything over the cap "shall be treated as a net operating loss," in the statute's words.

Both roads end at the same place, and that is where the leak is. Under Section 172(a)(2)(B), a net operating loss arising after 2017 can offset no more than 80 percent of taxable income in the year you carry it to. The IRS puts it this way in the Instructions for Form 172, revised December 2024: the NOL deduction "can't exceed 80% of taxable income without regard to the NOL deduction or sections 199A or 250."

So a dollar of deduction you can use this year shields a full dollar of income. That same dollar, routed through an NOL, shields eighty cents. Had you elected out, the $180,000 would have come back to you across the normal five, seven, and fifteen-year schedules as ordinary current-year deductions, every one of them worth a hundred cents on the dollar.

That is the whole argument, and it is an arithmetic argument, not a philosophical one. Nobody is suggesting you pay more tax than the law requires. Tax avoidance is the job. The question is which legal path leaves more money in your pocket measured across years rather than across one April.

When does electing out actually make sense?

Four situations come up often enough to be worth naming.

You are heading into higher rates. A deduction is worth your marginal rate. If this year you are at 22 percent and two years from now a business sale or a partner buyout puts you at 37 percent, deductions taken later are worth more than the same deductions taken now. Accelerating into a low-rate year spends them cheaply.

You are selling soon. The property a study reclassifies into shorter lives is largely Section 1245 property, and Section 1245 recapture comes back at ordinary income rates on sale, not at the friendlier capital gains rate. Accelerate a deduction at 24 percent, sell two years later, and recapture it at ordinary rates in a year when your income is already elevated by the sale, and you can finish behind where you started. I walked through how that math plays out in what happens when you sell a property after cost segregation. If a sale is on the calendar inside two or three years, run the recapture numbers before you take the deduction, not after.

Your state does not follow along. More than half the states decouple from federal bonus depreciation in some form, which means a deduction that saves you six figures federally can leave you with an addback and a state bill in the same year. Electing out federally makes the two sets of books agree. That is a real convenience with a real price, and it only wins when the federal deduction was not doing much for you in the first place. I covered which states do what in bonus depreciation is back at 100 percent, but your state may not have gotten the memo.

You have credits waiting in line. A credit cuts your tax bill dollar for dollar, but only down to a floor. Section 38(c)(1) caps general business credits, the R&D credit included, at your net income tax minus the greater of your tentative minimum tax or "25 percent of so much of the taxpayer's net regular tax liability as exceeds $25,000." Wipe out your regular tax with a year of bonus depreciation and the credits have nothing left to land on. Under Section 39 they carry back one year and forward 20, so they are not gone. They are parked, and a parked credit has a clock on it. I wrote about that clock in the R&D tax credit you earned might expire before you use it. If you are carrying credits forward, model the deduction and the credits together before you take either one.

Now the reason that sounds right and is not. Electing out does not fix a passive loss problem. If your rental losses are suspended under the passive activity rules because you are not a real estate professional and the short-term rental rules do not reach you, slowing the depreciation down does not make the deductions usable. It produces smaller suspended losses instead of larger ones. Suspended losses are not lost, they carry forward and free up when you have passive income or sell the property. The fix for a passive loss problem is participation status, not the depreciation election.

What if my property was under contract before January 20, 2025?

Then you may not be choosing between 100 percent and zero at all.

The One Big Beautiful Bill Act restored 100 percent bonus depreciation for property acquired after January 19, 2025. Its effective date provision adds that "property shall not be treated as acquired after the date on which a written binding contract is entered into for such acquisition." Sign a binding contract on January 10, 2025, close in March, and you are on the old rules no matter what the closing date says.

The old rules phase down. IRS Publication 946, 2025 revision, states that for qualified property acquired after September 27, 2017 and before January 20, 2025, "you must take a 40% special depreciation allowance" if it is placed in service during 2025. The prior-law schedule drops that to 20 percent for 2026. Giving up 20 percent is a far smaller sacrifice than giving up 100, so every situation above tips toward electing out more easily. IRS Notice 2026-11 is the interim guidance on applying the existing regulations to the new dates. Confirm which side of the line your property sits on before you model anything.

How do you make the election, and can you change your mind?

You attach a statement to Form 4562 identifying the class of property and stating that you are making the election under Section 168(k)(7). The regulation requires it to be filed "by the due date, including extensions, of the Federal tax return for the taxable year in which the qualified property is placed in service." CSSI, whose studies I deliver, walks through the same statement requirements in its article on amending a return to take bonus depreciation.

If you forgot to make it, there is one clean fix. The Instructions for Form 4562 (2025) say: "If you timely filed your return without making an election, you can still make the election by filing an amended return within 6 months of the due date of the return (excluding extensions)." The amended return has to carry the words "Filed pursuant to section 301.9100-2." For an individual with an April 15 due date, the window closes October 15, even if you extended.

Form 3115 will not save you here. That is the accounting method change form, and it is how you catch up on depreciation you never claimed. A missed election is a different animal. The regulations say making a late depreciation election, or revoking a timely one, "is not a change in method of accounting." Outside the six-month window, the door is a private letter ruling.

Changing your mind is where people get hurt. The statute says the election "may be revoked only with the consent of the Secretary," and the regulation spells out what that means in practice: revocation normally requires "filing a request for a private letter ruling and obtaining the Commissioner of Internal Revenue's written consent." That is a real expense and a real wait.

There is one escape hatch worth knowing. Treasury Regulation 1.168(k)-2(f)(5)(ii) grants an automatic six-month extension from the unextended due date of the return to revoke the election, provided you filed the original return on time and everyone whose tax liability is affected files amended returns consistent with the revocation. Six months from an unextended due date is not long. Treat the election as a decision you make once, with the modeling done first.

One piece of timing has already closed. Revenue Procedure 2026-17, effective March 18, 2026, let certain taxpayers withdraw a Section 163(j) real property trade or business election and make a late Section 168(k)(7) election on the same amended return. That window ran to October 15, 2026 at the outside, and earlier for many filers whose assessment period expired first. If you were watching that door, it is shut. I wrote about the underlying interest deduction change in the interest deduction game just changed.

Separately, there is a different election under Section 168(k)(10) that lets some taxpayers take a reduced percentage rather than declining bonus entirely. It is a distinct provision with its own timing rules, and I keep the details on how bonus depreciation works.

What does this have to do with a cost segregation study?

Everything, because the study is what creates the choice.

Without a study, a commercial building depreciates over 39 years and a residential rental over 27.5, straight line, and there is nothing to elect out of. Bonus depreciation never touches the building itself. It reaches the five, seven, and fifteen-year components, and the only way to know which components those are, and what they are worth, is an engineering-based study that puts a trained professional inside the building and prices the components against the construction documents. Desktop estimates and rule-of-thumb percentages produce a number. They do not produce the documentation that holds up when an examiner asks how you got it.

So the sequence is: study first, then the election decision, class by class, with your CPA looking at the same numbers you are. A good study hands you three separate decisions and the data to make each one. That is worth more than a single large number on a single line.

If you want to see what a study would find in your building, and what the deduction would actually be worth to you rather than what it would look like on paper, that analysis is free. Details on the service are at davidhwiener.com, and I talked through the version of this trap that catches investors most often on the podcast in the cost segregation deduction trap that catches investors off guard.

FAQ

Is bonus depreciation mandatory? Yes, by default. Bonus depreciation applies automatically to qualified property unless you affirmatively elect out under Section 168(k)(7) for that class of property and that tax year.

Can I elect out of bonus depreciation on just one asset? No. The election applies to every piece of qualified property in the same class placed in service during the same tax year. You can decide differently for five-year property than for fifteen-year property, but not for two items inside the same class.

How do I elect out of bonus depreciation? You attach a statement to Form 4562 identifying the class of property and stating that you are electing under Section 168(k)(7). It has to be filed by the due date of the return for the year the property was placed in service, including extensions.

Can I reverse an election out of bonus depreciation? Usually only by requesting a private letter ruling and obtaining the Commissioner's written consent. There is a narrow automatic exception: an extension of six months from the unextended due date of a timely filed return, if all affected taxpayers file consistent amended returns within that window.

I forgot to elect out on my return. Can I still do it? Yes, if you filed on time and move quickly. You can make the election on an amended return filed within six months of the original due date, not counting extensions, marked "Filed pursuant to section 301.9100-2." After that window you need a private letter ruling. Form 3115 does not work, because a late depreciation election is not a change in accounting method.

Does electing out help if my rental losses are suspended? No. The passive activity rules decide whether you can use a rental loss, and slowing your depreciation down does not change that. It produces a smaller suspended loss rather than a larger one. The answer to a passive loss problem is your participation status, not your depreciation election.

Run the numbers before you sign the return

The biggest first-year deduction and the best outcome are usually the same thing. Not always. The cases where they diverge are specific and they are knowable in advance, and every one of them turns on facts you already have: your rate this year against your rate later, whether a sale is coming, what your state does, whether credits are waiting, and how much income the deduction actually has to land on.

If you own a building, or you are about to, the no-cost analysis tells you what a study would find and what it would be worth, before you commit to anything. No obligation and no pitch. If a study will not pay for itself on your property, I will say so and save you the fee.

Grab a time on Calendly at calendly.com/david-wiener/cs or call 770-224-8504, option two. Cost segregation, 179D, and R&D credit studies are delivered through my relationship with CSSI (Cost Segregation Services, Inc.).

This article is educational and is not tax, legal, or accounting advice. Every situation is different; work with a qualified tax professional before acting on any strategy described here.