Beginning with the 2026 franchise tax report, a taxable entity that subtracts cost of goods sold (COGS) includes the depreciation reported on its federal return, bonus depreciation and section 179 amounts included, to the extent the assets are associated with and necessary for the production of goods. Earlier reports used the 2007 Internal Revenue Code, which allowed no bonus depreciation in COGS. The 2026 report also allows a one-time net depreciation adjustment for older production assets. For a COGS filer, production assets that a cost segregation study moves into the 5-, 7- or 15-year classes now carry their federal deductions into the Texas computation; entities using another margin method, the E-Z computation or below the no-tax-due threshold see no direct change.
What Changed Beginning With the 2026 Report
The federal rule. The One Big Beautiful Bill Act (OBBBA) made 100 percent bonus depreciation permanent for qualified property acquired and placed in service after January 19, 2025. Property acquired before January 20, 2025 stays on the phase-down, 40 percent if placed in service in 2025 and 20 percent in 2026.
A revised reading of existing law. On December 1, 2025, the Comptroller announced a revised interpretation of the franchise tax depreciation rules after a statutory review. The Comptroller’s FAQ states the result: beginning with the 2026 report, a taxable entity determines amounts taken from its federal return under the federal tax law in effect for that federal tax year, unless a Texas statute or rule specifically references the Internal Revenue Code. Where one does, the 2007 Code still applies. The change reaches every component of the franchise tax.
Depreciation in COGS. Texas Tax Code section 171.1012(c)(6) allows depreciation reported on the federal return, to the extent associated with and necessary for the production of goods, and references the Code only for section 197 recovery. The Comptroller therefore includes the federal figure for each qualifying asset, bonus depreciation included. Federal section 179 expense may also be included if the asset otherwise qualifies. Section 197 amortization is still figured under the 2007 Code, and an entity generally uses the same methods it uses on its federal return (section 171.1012(h)).
The rules. Rule 3.587 (total revenue) amendments took effect March 1, 2026, and the Rule 3.588 (cost of goods sold) amendments, proposed in the Texas Register on April 3, 2026, were adopted without changes effective June 21, 2026.
| Report | Depreciation in Texas COGS |
| 2025 and earlier | 2007 Code; no bonus; section 179 limit of $25,000 for amounts incurred after 2009 |
| 2026 | Federal return figures, plus one-time net adjustment |
| 2027 and later | Federal return figures |
Who the COGS Deduction Reaches
Taxable entities. The franchise tax applies to corporations, LLCs, S corporations and partnerships, among others; sole proprietorships (other than single-member LLCs), general partnerships owned entirely by natural persons and certain passive entities are outside it (Publication 98-806).
Four ways to compute margin. Publication 98-806 lists total revenue times 70 percent, total revenue minus COGS, total revenue minus compensation, and total revenue minus $1 million. Rule 3.588 lists the E-Z computation as a further option for entities that qualify. The election is made each year on the report, and an amended report filed within the period in Tax Code section 111.107 can change the method. Depreciation affects the tax through COGS, so an entity that uses another method or the E-Z computation does not take this deduction.
Who may use COGS. The Comptroller’s COGS FAQ states that the only taxable entities eligible to use COGS are those that sell real or tangible personal property in the ordinary course of business, and that a service is not a sale of tangible personal property. The pages reviewed for this article do not address an entity whose receipts are rent, so a landlord should confirm eligibility with its adviser.
The no-tax-due threshold. For the 2026 report, an entity with annualized total revenue of $2,650,000 or less owes no franchise tax and files an information report instead (Tax Code section 171.006; Tax Policy News, April 2026).
The One-Time Net Depreciation Adjustment
Qualifying assets. On the 2026 report only, a COGS filer may add a net depreciation adjustment for each qualifying asset. An asset qualifies if it is associated with and necessary for the production of goods, was placed in service before the start of the accounting year on which the 2026 report is based, and was not disposed of before that date.
The computation. For each year the asset was in service, through the accounting period end date on the 2025 report, subtract the depreciation claimed in Texas COGS from the depreciation claimed on the federal return. A year in which no depreciation was claimed in COGS counts as zero. The yearly amounts are added, and the net adjustment for an asset cannot be less than zero. Section 197 recovery is excluded.
The limit. The adjustment comes after all other COGS costs, including the year’s depreciation, and is used only to the extent it does not take margin below zero. Unused adjustment carries forward to consecutive reports until exhausted.
Illustration. A manufacturer used the COGS method every year, and its 2026 report is based on its 2025 accounting year.
| Asset | Federal depreciation claimed | Texas COGS depreciation | Net adjustment |
| Production line, in service 2021 | $500,000 | $300,000 | $200,000 |
| Equipment, in service 2019 | $80,000 | $95,000 | $0 (floor) |
| Equipment, in service during 2025 | Not a qualifying asset | Not a qualifying asset | Federal figure enters COGS directly |
Figures are hypothetical; the 2026 net adjustment is $200,000.
What a Cost Segregation Study Changes for a COGS Filer
Production assets carry their federal deductions. A study separates 5-, 7- and 15-year property from the 39-year building. For a COGS filer, whatever federal depreciation those assets generate, including 100 percent bonus on property acquired and placed in service after January 19, 2025, enters COGS beginning with the 2026 report, to the extent the assets are associated with and necessary for production. Our industrial and warehouse cost segregation page covers plants and distribution buildings.
The production share is a factual question. Only depreciation associated with and necessary for production counts, and the study’s asset-level cost detail helps show which components serve production areas rather than offices or selling space.
Assets placed in service in the 2025 accounting year. These are not qualifying assets for the one-time adjustment, because their federal and Texas COGS basis is the same. Their federal depreciation enters COGS directly on the 2026 report. In adopting Rule 3.588, the Comptroller stated that “there is not a carryforward provision in COGS for unused costs,” so a large first-year deduction that exceeds what reduces margin to zero is not carried to later reports.
Look-back studies. A study on a building placed in service in an earlier year is usually implemented through an accounting method change with a section 481(a) adjustment; our guide on when to do a cost segregation study covers that route. The Comptroller’s pages reviewed for this article do not say whether that adjustment counts as depreciation reported on the federal return for COGS, so confirm the Texas treatment before filing. Research credits are covered in our article on the Texas R&D tax credit.
If you own a production facility in Texas and are weighing a study ahead of your next report, request a no-cost analysis from CSSI Services.
Frequently Asked Questions
Does Texas allow bonus depreciation for the franchise tax?
For a COGS filer, yes, beginning with the 2026 report. Depreciation reported on the federal return, including bonus, is included in COGS to the extent the assets are associated with and necessary for the production of goods. Earlier reports used the 2007 Code, which allowed no bonus in COGS.
Which report years are affected?
The 2026 report and later reports. The one-time net depreciation adjustment is available on the 2026 report only, with any unused amount carried forward to consecutive reports.
Does the change help an entity that uses the compensation deduction or the E-Z computation?
Not directly. Depreciation enters the franchise tax through the COGS deduction, so it matters to entities that elect COGS. The election is made each year, and an amended report filed within the period in Tax Code section 111.107 can change the method.
Does a cost segregation study change my Texas franchise tax?
It can, if the entity elects COGS and the reclassified assets serve production. Those assets carry their federal depreciation, including bonus, into COGS beginning with the 2026 report. The treatment of a section 481(a) adjustment from a look-back study is not addressed in the Comptroller’s pages reviewed.
This article provides general information about federal and state tax rules and is not tax advice. Speak with your tax adviser about your specific circumstances.
