Qualified production property: Guidance signals potential for major savings

The IRS and U.S. Department of the Treasury have provided interim guidance on a powerful new tax incentive for domestic producers: a 100% special depreciation allowance for QPP under section 168(n).

This provision, enacted as part of the One Big Beautiful Bill Act (OBBBA), allows for the immediate expensing of certain nonresidential real property used in manufacturing, production or refining activities. This is a significant departure from normal depreciation rules, which require nonresidential real property to be written off over 39 years.

The guidance provides a detailed roadmap for taxpayers looking to benefit from this immediate expensing opportunity for facilities placed in service after July 4, 2025. Many businesses will celebrate the new rules, which are largely very favorable to taxpayers.

The notice provides the first detailed rules on:

• What property qualifies
• What activities are considered ‘production’
• How to make the required election
• Potential for recapture 

QPP is a new class of nonresidential real property that is integral to a taxpayer’s domestic production activities. To be eligible for the 100% bonus depreciation allowance, property must meet a series of requirements.

QPP is the portion of nonresidential real property that is:

• Subject to the Modified Accelerated Cost Recovery System (MACRS)
• Used by the taxpayer as an integral part of a ‘qualified production activity’ (QPA)
• Placed in service in the United States or a U.S. territory
• Original use beginning with the taxpayer (though an exception exists for certain used property)
• Construction beginning after Jan. 19, 2025, and before Jan. 1, 2029
• Placed in service after July 4, 2025, and before Jan. 1, 2031.
• Designated as QPP via an election on the taxpayer’s return.
• Not property for which the taxpayer is required to use the Alternative Depreciation System (ADS).

Certain acquired used property can qualify, which is a significant provision in the new guidance. If the used property is acquired after Jan. 19, 2025, and before Jan. 1, 2029, it can be treated as meeting the original use and beginning-of-construction requirements, provided it was not previously used in a QPA by any person during the period beginning on Jan. 1, 2021, and ending on May 12, 2025, and meets other acquisition criteria.

Importantly, to determine the acquisition date, a taxpayer must look to the acquisition rules in the bonus depreciation regulations. Careful analysis of these rules should be undertaken to determine the acquisition date.

The notice provides several important rules that will affect planning and structuring:

Improvements as separate property: The notice provides a rule treating any improvement or addition to a building as a separate unit of property. This means that even if a main facility is ineligible (e.g., its construction began before the prescribed construction begin date), subsequent capital expenditures—such as an electrical system upgrade, a new roof or even certain capitalized maintenance costs—can independently qualify for the 100% QPP allowance if their own construction and placed-in-service dates fall within the eligibility window.

Integrated facilities: For large production campuses with multiple buildings, the notice allows taxpayers to treat multiple properties that operate as an integrated facility and that are physically located or co-located on the same piece or contiguous pieces of land, as a single unit of property for purposes of the ‘integral part’ test. This allows, for example, a newly constructed building for raw material storage to be considered integral to the QPA occurring in an adjacent, existing factory.

The election: The election to claim 100% bonus depreciation for QPP is made on a timely filed tax return for the year the property is placed in service. The election is irrevocable without IRS consent, which will only be granted in extraordinary circumstances.

A key feature of the election is the ability to designate the precise amount of basis to be expensed. On the required election statement, a taxpayer can specify a dollar amount of the eligible property's basis to be treated as QPP, allowing for partial immediate expensing.

Alternatively, the taxpayer can elect to treat the entire unadjusted depreciable basis of the eligible property as QPP. The notice clarifies that if a taxpayer makes the election but does not specify a dollar amount, the entire eligible basis is deemed to be designated as QPP. It is also important to note the election's interaction with other depreciation provisions. For example, making the QPP election automatically opts the taxpayer out of other bonus depreciation provisions for that property (e.g., bonus depreciation under section 168(k)).

While the new 100% bonus depreciation for QPP generally cannot be claimed by a lessor based on a tenant's activities, Notice 2026-16 provides crucial exceptions for businesses operating with related-party property and operating companies. These exceptions effectively allow certain lessors to ‘look through’ to the QPA of their related lessees.

One exception is made for structures involving commonly controlled pass-through entities. If a partnership, S corporation or individual leases property to a ‘commonly controlled person,’ the lessor can satisfy the ‘integral part’ requirement by reference to the lessee's QPA.

Common control generally exists where there is 50% or more common ownership (applying attribution rules under sections 267(b) and 707(b)) between the lessor and lessee. This test is satisfied if, in the year the property is placed in service, at least one of the following two conditions is met:

• The same persons own 50% or more of both the lessor pass-through entity and the lessee entity
• The lessor (either the individual or the pass-through entity itself) directly or indirectly owns 50% or more of the lessee

These tests must be met based on ownership for a majority of the taxable year in which the property is placed in service, and the taxpayer must own the property on the last day of such year.

This related party exception was among the most hotly anticipated items on taxpayers’ wish lists. These rules are welcomed by many manufacturing or production businesses that utilize a separate, but related, entity to hold their real estate.

The other exception applies to intercompany leases within a consolidated group. When one member of a consolidated group owns and leases property to another member, the notice treats the entire group as a single taxpayer, allowing the lessor member to qualify the property based on the lessee member's QPA.

Because many production facilities contain both eligible and ineligible space, taxpayers must allocate the property’s basis. The notice permits any reasonable method for this allocation, citing as examples square footage, cost segregation data and architectural plans. However, using employee headcount or time spent on activities is not considered a reasonable allocation method.

The notice also provides a specific rule for ‘dual-use infrastructure,’ such as a central HVAC or sprinkler system that serves both the eligible production floor and the ineligible office space. The basis of such infrastructure must also be allocated using a reasonable method that takes into account the actual or planned usage, such as by relying on architectural or engineering plans.

The guidance includes a helpful de minimis rule. If 95% or more of the physical space of a property satisfies the integral part requirement at the time the property is placed in service, the taxpayer may elect to treat the entire property as satisfying the integral part requirement, making the entire basis of the building eligible for 100% bonus depreciation.

The central eligibility criterion is that the property must be used as an integral part of a QPA. The notice defines a QPA as the manufacturing, production or refining of a qualified product that results in a ‘substantial transformation.’

The guidance defines key terms and concepts, including:

Substantial transformation: This occurs when a process fundamentally changes the form or function of raw materials or components, creating a new and distinct item of tangible personal property. The notice clarifies that activities like simple packaging or minor assembly do not qualify.

Essential and related activities: The guidance recognizes that a production process is more than just the assembly line. A QPA can also include ‘essential’ activities that are critical to the completion of the product, such as the receiving and storage of raw materials, if they occur in the same property (or integrated facility) as the qualified production activity. It can also include related activities like process oversight, quality control and management of production costs.

Contract manufacturers: Whether the taxpayer is the tax owner of the qualified product is not taken into account when determining whether their activity is a QPA. This means a contract manufacturer that uses its own facility to manufacture, produce or refine a product for a customer, even if the customer owns the raw materials and the resulting finished goods, is considered to be engaged in a QPA, provided the activity results in a substantial transformation.

Consequently, if the contract manufacturer owns the nonresidential real property (the factory) and uses it as an integral part of its own QPA, that property can be eligible for the 100% QPP special depreciation allowance, assuming all other requirements are met.

Ineligible activities: The notice specifically excludes certain functions from qualifying, even if they occur in the same building. These include office and administrative services, sales, research and development, lodging and parking. Critically, the storage of finished goods is not considered an essential activity and space used for this purpose is ineligible.

Qualifying activities: QPP includes nonresidential real property in the context of manufacturing, production or refining activities. The term ‘production’ in this context is limited to activities in the agricultural or chemical industries. Guidance on the distinctions and boundaries between each of these categories is necessary, especially between manufacturing and production as many taxpayers use these terms interchangeably.

Manufacturing: The notice defines ‘manufacturing’ as a process that materially changes the form or function of tangible personal property to create a new, distinct item that cannot be readily returned to its original state.

Refining: The term ‘refining’ is defined as the purification of a substance into a more useful and higher-value product, with the notice providing numerous examples such as processing petroleum, purifying metals and processing vegetable oils.

Production: Consistent with the QPP statute, the term ‘production’ is narrowly defined to mean either ‘agricultural production’ (such as cultivating land and raising crops or livestock) or ‘chemical production’ (the formulation of products via chemical processes). Helpfully, the notice provides examples in each category as well as exclusionary activities.

Recapture risk: The benefit comes with a 10-year lookback period. If, within 10 years of being placed in service, the property ceases to be used as an integral part of a QPA, the taxpayer must recapture the tax benefit as ordinary income. The recapture rules are complex, particularly for partial changes in use and require careful monitoring of facility operations.

The QPP guidance in Notice 2026-16 provides a valuable framework for taxpayers to begin planning now. While these rules are not yet final, taxpayers can rely on them for property placed in service before final regulations are issued.

Businesses in the manufacturing, agricultural and chemical sectors should consider taking the following steps:

1. Review capital expenditure plans: Identify any new construction, expansion or acquisition projects that fall within the construction and placed-in-service windows.
   
   
2. Analyze facility design: Proactively design new facilities to maximize the square footage dedicated to qualifying production activities and minimize ineligible space. The 95% de minimis rule may be a key design target.
   
   
3. Evaluate entity structure: For businesses with related-party leases, analyze the consolidated group and commonly controlled entity exceptions to ensure the structure does not inadvertently disqualify the property.
   
   
4. Look for other impacts: The rule treating improvements as separate property creates unique planning opportunities. For example, the notice highlights a scenario where a taxpayer elects to capitalize routine maintenance costs under the tangible property regulations book conformity election. Because the capitalized cost in the example is an ‘improvement,’ it becomes a separate unit of property eligible for the 100% QPP deduction. The result is the same immediate $100,000 deduction, but its character changes from an ordinary repair expense to depreciation.
   
   This is a critical distinction, as the depreciation can now be added back in computing a taxpayer's section 163(j) adjusted taxable income, potentially increasing the business interest expense limitation. This benefit must be weighed against state tax conformity, as some states may not allow the 100% QPP deduction but would have allowed the ordinary repair deduction.
   
   In a similar context, too much depreciation may be too much for a good thing. For example, the section 250 deduction for foreign-derived deduction eligible income and net CFC tested income (NCTI) is capped by the taxpayer’s taxable income for the year, determined without regard to the section 250 deduction. A substantial QPP deduction can significantly lower or even eliminate taxable income, which could trigger this limitation and reduce or nullify the benefit of the section 250 deduction against NCTI inclusions. The availability to elect a specific dollar amount of qualifying property as QPP may prove beneficial for certain taxpayers.
   
   
5. Implement documentation processes: Establish robust procedures for documenting the basis allocation between eligible and ineligible property and for tracking the use of the property to mitigate future recapture risk.
   
   An experienced advisor can help businesses evaluate eligibility, model the tax impact of different elections and document how facilities and activities meet the QPP rules. By aligning these technical requirements with broader capital plans, an advisor can help companies make informed decisions that support operational needs and long‑term tax outcomes.