1. What a cost segregation study does
A building normally depreciates over 27.5 years (residential) or 39 years (commercial). A cost segregation study breaks the purchase price apart and reclassifies components like flooring, cabinetry, dedicated electrical, and land improvements into 5, 7, and 15-year property, so a large slice of the basis depreciates on much shorter schedules.
On the federal return, that reclassified property also qualifies for bonus depreciation, which restores a 100% first-year write-off for qualifying property acquired and placed in service after January 19, 2025. States set their own rules, which is where Arizona comes in.
2. Arizona and federal bonus depreciation
For individual income tax (including pass-through owners of rentals), Arizona technically decouples on paper but fully conforms in effect: A.R.S. 43-1021(11) adds back federal depreciation, and A.R.S. 43-1022(17)(e) then allows a subtraction equal to depreciation computed 'as if the additional allowance for depreciation had been the full amount allowed pursuant to section 168(k)' for assets placed in service in tax years beginning after December 31, 2016 -- a wash that delivers 100% bonus on the Arizona return. Because HB 4168 (2026) moved the conformity date to January 1, 2026 retroactive to TY2025, this includes OBBBA's permanent 100% bonus for property acquired after January 19, 2025. Corporations are genuinely decoupled: A.R.S. 43-1121/43-1122 force an addback and allow only the depreciation that would result from electing out of bonus under 168(k)(7). HB 4168 also decoupled BOTH individuals and corporations from the new IRC 168(n) qualified production property 100% allowance for tax years beginning after December 31, 2025 (addbacks at A.R.S. 43-1021(17) and 43-1121(25)).
Individuals: the statute adds back federal depreciation (A.R.S. 43-1021(11)) and subtracts Arizona depreciation recomputed with 100% of the federal 168(k) bonus for post-2016 assets (43-1022(17)(e)); per ADOR procedure ITP 16-2 this is reported as a net bonus addback plus an equal Arizona bonus subtraction on Form 140 -- net zero difference, recovered immediately rather than over time. Corporations: add back bonus and recover it as ordinary MACRS depreciation over the asset's full recovery period, computed as if the 168(k)(7) election out had been made. New IRC 168(n) amounts (TY2026+) are added back by both individuals and corporations and recovered through regular depreciation.
Worked example
A $1,000,000 building, with and without a study
Illustrative only. A residential rental purchased for $1,000,000 of building basis (land excluded), acquired and placed in service after January 19, 2025.
Building basis
$1,000,000
Reclassified to 5, 7, and 15-year property (25%)
$250,000
Federal first-year deduction at 100% bonus
$250,000
Year 1 on that $250,000 without a study (27.5-year straight line)
about $9,100
Arizona allows only part of the federal bonus deduction. Individuals: the statute adds back federal depreciation (A.R.S. 43-1021(11)) and subtracts Arizona depreciation recomputed with 100% of the federal 168(k) bonus for post-2016 assets (43-1022(17)(e)); per ADOR procedure ITP 16-2 this is reported as a net bonus addback plus an equal Arizona bonus subtraction on Form 140 -- net zero difference, recovered immediately rather than over time. Corporations: add back bonus and recover it as ordinary MACRS depreciation over the asset's full recovery period, computed as if the 168(k)(7) election out had been made. New IRC 168(n) amounts (TY2026+) are added back by both individuals and corporations and recovered through regular depreciation.
Model your own numbers with the tax strategy projector.
3. Section 179 in Arizona
Arizona imposes no state-specific Section 179 cap and no 179 addback exists in A.R.S. 43-1021 or 43-1121. With the conformity date moved to January 1, 2026, Arizona adopts OBBBA's increased federal 179 limits ($2.5 million deduction limit with the $4 million (indexed) phaseout threshold) for property placed in service after December 31, 2024, for both individuals and corporations.
4. Does it still help in Arizona?
Yes -- Arizona computes income from federal AGI/federal taxable income and follows federal MACRS recovery periods (5/7/15/27.5/39-year), so a cost segregation study's reclassification carries straight onto the Arizona return; for individuals the bonus itself also flows through in full, and even for C-corps (no bonus) the shorter MACRS lives still accelerate state deductions.
- •Arizona is an annual-update static conformity state; HB 4168 (signed June 13, 2026) advanced the IRC conformity date from January 1, 2025 to January 1, 2026, generally retroactive to tax years beginning after December 31, 2024 -- so TY2025 Arizona returns pick up OBBBA provisions. Two earlier 2026 conformity vehicles (HB 2785 and SB 1845) were vetoed by Governor Hobbs before HB 4168 passed as part of the budget deal.
- •The individual 'decoupling' is cosmetic: the addback (A.R.S. 43-1021) and subtraction (A.R.S. 43-1022(17)(e)) net to exactly the federal 168(k) deduction for assets placed in service in tax years beginning after 12/31/2016, so individual investors get 100% bonus on the AZ return -- but the adjustment lines still must be reported (ADOR procedure ITP 16-2).
- •Legacy phase-in matters for older assets: the Arizona individual bonus subtraction was only 10% of federal bonus for assets placed in service in taxable years beginning after 12/31/2013 through 12/31/2015, and 55% for taxable years beginning after 12/31/2015 through 12/31/2016; assets from taxable years beginning before 2013 required recomputing depreciation as if no bonus was claimed.
- •C-corporations get no 168(k) bonus at all in Arizona: they add back bonus and depreciate as if they had elected out under 168(k)(7).
- •HB 4168 decoupled BOTH individuals and corporations from the new IRC 168(n) 100% allowance for qualified production property for tax years beginning after December 31, 2025 (new addbacks at A.R.S. 43-1021(17) and 43-1121(25)) -- unlike 168(k), individuals get no offsetting 100% subtraction for 168(n).
- •Arizona's flat 2.5% individual income tax rate (one of the lowest in the nation) means the dollar value of state-side cost-seg savings is modest relative to high-rate states, even though conformity is investor-friendly.
- •Arizona also conforms (via HB 4168) to OBBBA's restored IRC 174A immediate R&D expensing and the restored EBITDA-based 163(j) limit for tax years beginning after December 31, 2024.
- •Pass-through owners can elect Arizona's Small Business Income (SBI) return, also taxed at 2.5% for current years; rental/business depreciation adjustments flow through the same addback/subtraction mechanics on the SBI forms.
5. The exit: recapture and timing
The accelerated deductions come back into view when you sell. Gain attributable to the 5, 7, and 15-year property is Section 1245 recapture, taxed at ordinary rates, and the straight-line depreciation on the building itself is unrecaptured Section 1250 gain, taxed at up to 25%. A study does not create that bill, it moves deductions forward, but the timing of the sale decides how much of the benefit you keep.
Two levers manage the exit. A 1031 exchange defers both flavors of recapture along with the rest of the gain, and simply holding the property lets the time value of the early deductions do its work; most owners want a 3 to 5 year horizon before a taxable sale for the math to stay comfortably positive. Model the exit before you commission the study, not after.