Arizona does not conform to federal §168(k) — 100% of your federal bonus depreciation must be added back on the Arizona state return. The federal deduction is unaffected; on the Arizona side you recover the timing difference through standard MACRS depreciation over the property's 5/15/27.5-year life. Because Arizona uses a 2.5% flat tax, the dollar hit is the smallest of any decoupled state. For side-by-side context, the 50-state §168(k) conformity overview shows how Arizona stacks up against every other US jurisdiction.
Modeled on a $150,000 federal §168(k) deduction.
How Arizona Treats §168(k) — The Add-Back Mechanic
Arizona requires taxpayers to add back federal depreciation computed under §167(a) that includes any §168(k) bonus deduction, and then to subtract Arizona depreciation computed as if the taxpayer had elected out of §168(k) under §168(k)(2)(D)(iii). The net effect: Arizona ignores bonus depreciation entirely and depreciates the asset on the standard IRC §168(a) schedule.
The controlling statutes are A.R.S. §43-1021 (individual additions to Arizona gross income) and A.R.S. §43-1022 (individual subtractions). Guidance is codified in Arizona Individual Tax Procedure ITP 16-2, which the Arizona Department of Revenue maintains as its primary published position on the mechanics. Federal Schedule E net rental income is imported into the Arizona return, then the §168(k) piece is added back and a smaller regular-MACRS deduction is subtracted.
Practically, for a short-term rental placed in service after January 19, 2025, the STR investor still claims the full 100% federal bonus under OBBBA (P.L. 119-21) — the federal Schedule E deduction is unaffected. On the AZ Form 140 individual return, the add-back is required and Arizona depreciation continues on a straight-line-adjusted MACRS basis over the asset's normal life.
Worked Example — $150,000 Federal Deduction on an Arizona STR
Assume an STR investor buys a Sedona property, closes 2026, and identifies $150,000 in bonus-eligible 5-year and 15-year assets through a cost-segregation-quality report.
| Line | Federal | Arizona |
|---|---|---|
| Year 1 §168(k) deduction (bonus-eligible portion) | $150,000 | $0 (100% add-back) |
| Year 1 tax savings @ 37% federal / 2.50% AZ flat | $55,500 | $0 |
| Year 1 Arizona MACRS recovery (approx.) | — | ~$16,900 (blended 5/15/27.5-yr MACRS) |
| Years 2 through end of asset life — AZ subtraction modification | — | Remaining ~$133,100 recovered ratably |
The Year-1 Arizona miss is roughly $3,750 in state tax that would have been saved had Arizona conformed ($150,000 × 2.50%). That timing loss reverses as Arizona depreciation deductions exceed federal in later years. The 2.5% flat rate makes this the smallest state-level penalty of any decoupled jurisdiction in the country.
Pre-purchase, you can run the address on your property to see the combined federal-and-state after-tax cash flow before you write an offer.
The Statute Explained
Arizona is a rolling-conformity state for most IRC purposes — Arizona gross income begins with federal adjusted gross income and updates automatically as the IRC changes. But §168(k) is a carve-out. A.R.S. §43-1021 requires the specific add-back of federal §168(k) bonus depreciation, and A.R.S. §43-1022 authorizes the offsetting subtraction for the recomputed Arizona depreciation. This structure — rolling conformity with a §168(k) carve-out — is the same architecture used by Idaho and (in different form) Massachusetts and Virginia.
Because the carve-out is statutory rather than tied to a fixed IRC date, the OBBBA restoration of 100% federal bonus for property placed in service after January 19, 2025 does not change the Arizona treatment. The add-back requirement stands until the legislature amends A.R.S. §43-1021/§43-1022 or repeals the depreciation carve-out.
How Arizona Compares to Federal-Conforming States
Of the 50 states plus DC, roughly half conform to federal §168(k) and take the federal deduction as-is. In a rolling-conformity, fully-adopting state like Colorado (4.4% flat) or Alabama (5.0% top marginal), the same $150,000 federal deduction produces $6,600 or $7,500 in additional Year-1 state savings on top of the federal $55,500 — a meaningful stacking benefit.
Arizona sits at the opposite end: 100% add-back, no Year-1 state benefit. But because Arizona's 2.5% flat rate is the lowest of any decoupled state, the dollar penalty is small — roughly $3,750 on a $150,000 deduction, versus ~$19,950 in California or ~$16,500 in Hawaii on the same deduction. Compare the mechanics against how California does it, or use the state conformity tool to run Arizona side-by-side with any other state at any federal deduction amount.
What This Means for Your STR Purchase Decision
Two things follow from Arizona's decoupling for an STR investor evaluating a property in Sedona, Scottsdale, or Flagstaff. First, the federal Year-1 bonus deduction is the entire economic story — Arizona adds essentially nothing on top, and takes nothing away either. Second, the state-side timing loss is small enough that it should not swing an offer decision on its own; the federal §168(k) analysis remains dominant.
Before you write an offer on any Arizona STR placed in service after January 19, 2025, model both the federal Year-1 deduction and the Arizona add-back in your after-tax return. The federal 100% bonus under OBBBA is a real number; the Arizona side is a rounding error at 2.5%. Run the address on your property to get a line-item breakdown before committing.
Analyze a specific Arizona property
Run any Arizona STR listing through DepreciMax's $99 property report — line-item finish classification closely calibrated to a formal cost seg study, includes Arizona-specific add-back math.
Frequently Asked Questions
Does Arizona plan to conform to §168(k) in 2026?
No. Arizona has statutorily required an add-back of federal §168(k) bonus depreciation for years and no 2026 legislation has been introduced to conform. A.R.S. §43-1021 and §43-1022 continue to require taxpayers to compute Arizona depreciation as if the §168(k) election were not made.
Can I still take federal bonus depreciation if I live in Arizona?
Yes. The federal §168(k) deduction is unaffected by Arizona's decoupling. An STR investor placing a property in service after January 19, 2025 can claim the full 100% federal bonus deduction under OBBBA (P.L. 119-21). Arizona only changes the state-return calculation.
How do I report the Arizona §168(k) add-back?
Arizona taxpayers add back federal §167(a) depreciation and subtract Arizona depreciation computed as if the taxpayer had elected out of §168(k) under §168(k)(2)(D)(iii). Guidance is in Arizona Individual Tax Procedure ITP 16-2.
What happens on sale — does Arizona recapture the difference?
Because Arizona basis exceeds federal basis by the amount of the add-back that has not yet reversed, disposition gain is smaller on the Arizona return than on the federal return. The state timing difference reverses over the MACRS life through subtractions and, at sale, through a lower Arizona gain.
Does Arizona's decoupling apply to §179 too?
No. Arizona conforms to federal §179 expensing. The decoupling in A.R.S. §43-1021/§43-1022 is narrowly targeted at §168(k) bonus depreciation only.
Every state's §168(k) position, in one place
Interactive map, sortable table, and deep-dive guide for each of the 51 jurisdictions — post-OBBBA verified.
See the 50-state map →Arizona statute: A.R.S. §43-1021 / §43-1022; Arizona Department of Revenue ITP 16-2 (azdor.gov/legal/procedures/itp-16-2). Federal authority: IRC §168(k), as amended by the One Big Beautiful Bill Act (P.L. 119-21) restoring 100% bonus depreciation for property acquired and placed in service after January 19, 2025. Nothing in this article is tax advice. Consult a CPA who specializes in real estate before making investment decisions based on state-conformity projections.