Before the One Big Beautiful Bill Act, a manufacturer spending $100 million to build a new US production facility would write it off at roughly $2.5 million per year over 39 years. Section 168(n) of the Internal Revenue Code, added by Section 70307 of the OBBBA signed July 4, 2025, changes that entirely for qualifying facilities: the entire depreciable cost can be deducted in the year the facility is placed in service.
On February 20, 2026, the IRS and Treasury issued Notice 2026-16, the first interim guidance on how Section 168(n) works in practice. Taxpayers can rely on Notice 2026-16 until proposed regulations are issued. This post covers exactly what qualifies, what the key rules in the notice say about buildings with mixed uses, how the election works, and what the 10-year recapture rule means for your balance sheet and tax provision before you break ground.
What Is the Section 168(n) Qualified Production Property Deduction?
Section 168(n) provides a 100% special depreciation allowance for qualified production property placed in service in the United States after July 4, 2025, and before January 1, 2031. The allowance is taken in the taxable year the property is placed in service. QPP is broadly defined as nonresidential real property used as an integral part of a qualified production activity.
Before the OBBBA, nonresidential real property was depreciated over 39 years using the straight-line method. There was no mechanism to accelerate recovery of a manufacturing building's cost beyond cost segregation, which could reclassify some structural components into shorter asset classes but could not convert the building shell itself into a current-year deduction. Section 168(n) creates a separate depreciation class, outside the existing bonus depreciation rules of Section 168(k), that applies specifically to production facility real property.
The deduction applies to the unadjusted depreciable basis of the qualifying property. Land is not depreciable and is excluded. The basis of the building and its structural components, meaning the portions that qualify as QPP, is what receives the 100% allowance. Once the election is made, the adjusted basis of the QPP is reduced to zero before computing any other depreciation, meaning no further depreciation deductions are available on the elected portion.
For tax provision purposes, a 100% deduction in year one on a $100 million building creates a $100 million temporary difference in the year placed in service. For most companies that expect to remain taxpayers in future years, this produces a $21 million current tax benefit (at 21%) in the year of placement with a corresponding deferred tax liability that unwinds over the period the building would otherwise have been depreciated. The net present value benefit is significant even accounting for the deferred tax unwinding.
The deduction applies for both regular tax and alternative minimum tax purposes, which eliminates the common concern that bonus depreciation benefits are partially eroded by the AMT.
How Is QPP Different From Regular 100% Bonus Depreciation?
This is the first question most tax directors ask, because the OBBBA also permanently restored 100% bonus depreciation under Section 168(k) for eligible property. Understanding where the two provisions intersect and where they differ is essential before making any election.
Section 168(k) bonus depreciation applies to tangible personal property and certain other assets with recovery periods of 20 years or less. Nonresidential real property, specifically the building and its structural components, is 39-year property and has never been eligible for Section 168(k) bonus depreciation. That is the core gap Section 168(n) fills. QPP under Section 168(n) is the mechanism to get a manufacturing building itself, not just the equipment and personal property inside it, into a first-year full expensing regime.
The two provisions do not stack on the same basis. If a taxpayer elects QPP treatment under Section 168(n) for a building, the 100% allowance is claimed under Section 168(n) rather than Section 168(k) for that property. QPP is treated as a separate class of property for this purpose. A company building a manufacturing facility would use Section 168(k) for the eligible equipment, machinery, and personal property inside the facility, and Section 168(n) for the building itself and its structural components that meet the QPP definition.
Cost segregation studies remain relevant. Certain components of a building that qualify as personal property or 15-year land improvements under cost segregation analysis are already eligible for Section 168(k). Section 168(n) handles what cost segregation cannot reach: the structural shell and 39-year components of the building. In practice, a comprehensive capital project involving a new production facility uses Section 168(k) for personal property and 15-year components identified through cost segregation, and Section 168(n) for the remaining 39-year building basis.
Note that property subject to the alternative depreciation system (ADS) does not qualify for Section 168(n). This exclusion catches a specific group of taxpayers: companies that made a real property trade or business election under Section 163(j) to deduct all business interest expense are generally required to use ADS for nonresidential real property. Those companies cannot claim the Section 168(n) QPP deduction on the ADS-classified property, which is a meaningful planning constraint for capital-intensive businesses with significant interest expense.
What Is a "Qualified Production Activity" and What Is Excluded?
The definition of a qualified production activity (QPA) is what determines whether a building qualifies as QPP. A QPA must meet two requirements: it must involve manufacturing, production, or refining of a qualified product, and it must result in a substantial transformation of that product.
Notice 2026-16 provides specific definitions for each activity type.
Manufacturing means materially changing the form or function of property, including its parts and components, to create a new item of property that is held for rent, lease, or sale. A material change requires that the parts and components be transformed to the point where they are distinguishable from, and cannot readily be returned to, their original states. Packaging, repackaging, labeling, minor assembly, or combinations of those activities alone do not constitute a material change. An auto assembly plant that fabricates components into a finished vehicle is manufacturing. A distribution center that receives finished goods and labels them for retail is not.
Production is limited to agricultural production and chemical production. Agricultural production is the raising of crops or livestock. Chemical production means the synthesis of one or more chemical compounds, including pharmaceuticals, agricultural chemicals, paints, coatings, adhesives, plastics, and similar products.
Refining means the process of improving the grade, quality, or purity of a material or substance, which includes purification, separation, and the removal of impurities.
A qualified product is tangible personal property held for rent, lease, or sale. This excludes real property. A building developer that constructs residential or commercial buildings for sale is not engaged in a QPA because the product, real property, is not tangible personal property. Similarly, software development, research activities, and engineering activities are not QPAs.
The notice provides a safe harbor for property placed in service after July 4, 2025, and on or before December 31, 2025: a taxpayer's activity is treated as a QPA if the principal business activity code on its most recently filed return corresponds to NAICS sectors 31, 32, or 33 (manufacturing) or subsectors 111 or 112 (crop and animal production), and the activity otherwise results in substantial transformation of a qualified product.
What Does "Substantial Transformation" Mean Under Notice 2026-16?
The substantial transformation requirement is the definitional filter that separates qualifying production activities from activities that simply handle, process, or redistribute existing products. Every QPA must involve a substantial transformation of a qualified product. The requirement is in the statute and Notice 2026-16 provides the operative definition.
Under the notice, a substantial transformation occurs when the manufacturing, production, or refining activity results in raw materials or inputs being transformed to the point where they are distinguishable from, and cannot readily be returned to, their original states. This is effectively a one-way transformation test: if the process could be reversed to return the inputs to their original form, the transformation is not substantial.
The notice gives clarity on activities at the edges. Related activities that do not themselves result in substantial transformation will not disqualify a taxpayer from having a QPA, as long as those activities occur within the same property or integrated facility as the activity that does produce the substantial transformation, and the individuals performing or supervising those related activities also perform activities related to the QPA. An example: a production facility supervisor who occasionally handles quality inspection of incoming raw materials is not separately treated as conducting a non-QPA activity that disqualifies the facility, as long as the inspection occurs within the facility space and the same individuals are involved in the production work.
Activities that the notice specifically excludes as standalone activities: receiving and storing finished products awaiting sale or distribution, sales activities, administrative activities, and any activity whose only physical location within the property is in ineligible space (offices, parking, etc.). These activities are not QPAs even if they support a QPA, unless they meet the related activity standard above.
The substantial transformation concept will be the primary area of IRS scrutiny in future examinations. Companies claiming Section 168(n) deductions should maintain contemporaneous documentation of what production activities occur within each facility, mapping those activities to the specific physical spaces of the building.
Which Parts of a Building Qualify and Which Don't?
This is the most practically important question for companies with facilities that are not pure production spaces. Most manufacturing facilities include offices, break rooms, administrative areas, parking structures, and other non-production spaces. The rules in Notice 2026-16 address how these mixed uses are treated.
The general rule is that property qualifies as QPP only to the extent it is used as an integral part of a QPA. Property is used as an integral part of a QPA if a QPA takes place within its physical space. If a QPA takes place only within a portion of a building's physical space, only that portion satisfies the integral part requirement.
The notice treats each building, including its structural components, as a single unit of property. Improvements or additions made to a building after it has been placed in service are each their own separate unit of property.
The following types of space are explicitly identified in Notice 2026-16 as ineligible property that cannot be treated as QPP, regardless of how closely they support the production activity:
Space used for offices or administrative services.
Space used for lodging or related services.
Space used for parking or related services.
Space used for retail sales or sales activities.
Space used for research activities, software development, or engineering activities.
Space used for storing finished goods awaiting sale or distribution.
Notably, storage of raw materials and manufacturing inputs used and consumed during a QPA can qualify as an essential activity if that storage occurs within the same property or integrated facility as the production activity. Storage of finished products going out the door is not QPP. Storage of raw materials coming in for production is.
The notice explicitly states that employee headcount is not a reasonable method for allocating basis between qualifying and ineligible space. A manufacturer cannot allocate 90% of the building's cost to QPP simply because 90% of employees work in the production area. Space-based allocation, cost segregation studies, or similar methods based on physical area or identifiable cost are acceptable. The taxpayer must use any reasonable method but cannot use headcount.
What Is the 95% De Minimis Rule for Mixed-Use Facilities?
Notice 2026-16 provides a de minimis safe harbor for facilities where the production use is dominant and the non-production space is minor. If 95% or more of a property's physical space satisfies the integral part requirement (meaning the QPA takes place within it), the taxpayer may elect to treat the entire property as QPP, including the ineligible 5% or less.
This rule is significant in practice. Many production facilities have a small administrative office, a single security guard station, or a modest employee restroom facility. Without the de minimis rule, the taxpayer would need to carve out and exclude those spaces from the QPP basis, requiring a precise allocation calculation. With the de minimis rule, if the ineligible space is 5% or less of total physical space, the entire facility's basis can be designated as QPP without allocation.
The 95% threshold is measured by physical space, consistent with the notice's general rejection of headcount as an allocation method. The taxpayer's calculation of physical space should be based on the actual square footage of the facility.
Where a facility does not meet the 95% threshold, the taxpayer must allocate the building's unadjusted depreciable basis between the qualifying QPP portion and the ineligible portion. The ineligible portion is excluded from the QPP election and continues to be depreciated over 39 years. The notice confirms that cost segregation studies and similar engineering analyses are acceptable allocation methods, and specifically calls out cost segregation as an approach the IRS has invited input on.
For facilities that just miss the 95% threshold, it is worth examining whether any of the ineligible space can be redesigned or repurposed before the building is placed in service. A small administrative office that is relocated to a separate off-site building before the production facility is placed in service eliminates that space from the QPP calculation, potentially pushing a facility from 92% to 97% qualifying space and allowing the entire building to be elected as QPP.
What Are the Construction Start and Placed-in-Service Deadlines?
Section 168(n) has two distinct date-based requirements, and both must be satisfied. Missing either disqualifies the property from QPP treatment entirely.
Construction must begin after January 19, 2025, and before January 1, 2029. The notice references the existing rules under Section 1.168(k)-2(b)(5) for when construction begins, which are the same rules that apply to self-constructed property for Section 168(k) bonus depreciation purposes. Construction begins when physical work of a significant nature starts, or when the taxpayer has paid or incurred more than 10% of the total cost of the property under a safe harbor. Physical work of a significant nature does not include preliminary activities such as planning, designing, securing financing, exploring, or researching. It also does not include work conducted to ready the site for construction, such as clearing and grading.
The construction start deadline of January 1, 2029 is the critical planning horizon for companies evaluating whether to pursue a QPP election. A facility where physical work of significant nature has not started before that date is ineligible regardless of when it is completed or placed in service.
The property must be placed in service after July 4, 2025, and before January 1, 2031. The placed-in-service deadline of January 1, 2031 gives companies a runway after the construction start deadline. A facility where construction begins in December 2028 (before the January 1, 2029 construction start cutoff) and is completed in 2030 still qualifies if it is placed in service before January 1, 2031.
The Secretary of the Treasury has authority to extend the placed-in-service deadline in extraordinary circumstances, specifically for property whose completion is delayed by an act of God such as a designated natural disaster. That extension authority does not apply to the construction start deadline.
Original use of the QPP must begin with the taxpayer claiming the deduction. There is a special rule for used property: existing nonresidential real property can qualify as QPP if it was not previously used in a qualified production activity by any person between January 1, 2021, and May 12, 2025, the taxpayer has not used the property before acquisition, and the property is not acquired from a related party. This used property exception creates an opportunity for companies that acquire previously non-production buildings and repurpose them into QPP-qualifying facilities.
What Does the QPP Election Look Like and Is It Reversible?
The QPP election must be made on a timely filed original federal income tax return, including extensions, for the taxable year in which the QPP is placed in service. An amended return cannot be used to make the election, and the election cannot be made retroactively.
The election is made by attaching a statement titled "STATEMENT PURSUANT TO SECTION 7 OF NOTICE 2026-16" to the return. The statement must include specific information about the property including a description of the property, the amount designated as QPP, the date the property was placed in service, and confirmation that the construction begin date requirement was satisfied.
Where a building contains both qualifying QPP space and ineligible space, the election designates a specific dollar amount of the building's unadjusted depreciable basis as QPP. The taxpayer is not required to elect QPP treatment for the maximum eligible amount. A company could elect QPP treatment for only a portion of the qualifying basis, for example if it anticipates state tax implications where a full deduction creates adverse results. However, the election must designate a specific amount that does not exceed the eligible QPP basis, and the IRS has not indicated that partial elections can be revoked and remade in subsequent years.
The QPP election is essentially irrevocable. Revocation requires IRS consent and the notice states that consent will be granted only in extraordinary circumstances. This is explicit and significant for companies evaluating the election: once made, the 100% deduction is locked in, the basis is reduced to zero, and the 10-year recapture clock begins running. The election is not a year-to-year choice that can be revisited based on subsequent business changes.
When a taxpayer makes a QPP election, the notice provides that the taxpayer is treated as having made an election under Section 168(k)(7) not to deduct additional first year depreciation under Section 168(k) with respect to the class of property to which the QPP belongs. This is a coordination rule that prevents double-counting. The company is not separately electing QPP treatment and then applying bonus depreciation to the same basis.
What Is the 10-Year Recapture Rule and How Does It Affect Your Balance Sheet?
Section 168(n) includes a recapture provision that has direct implications for how the election affects your balance sheet beyond the year of placement in service. If, within 10 years of the date the QPP is placed in service, the property ceases to be used as an integral part of a qualified production activity, the prior Section 168(n) deduction is recaptured as ordinary income in the year of cessation.
The recapture is treated as Section 1245 income, meaning it is taxed as ordinary income rather than capital gain, up to the amount of the original Section 168(n) deduction. Any gain beyond the original deduction amount (representing appreciation above the original cost basis) would be treated as capital gain. This Section 1245 treatment also means the property is not eligible for a Section 1031 like-kind exchange to the extent of the recaptured amount, and it cannot be exchanged into a tax-deferred structure as easily as capital gain property.
The notice includes examples of full recapture (the entire facility ceases production use within 10 years) and partial recapture (a portion of the facility stops being used in a QPA within 10 years). Partial recapture is calculated based on the proportion of the QPP designation that corresponds to the space that ceased qualifying use.
For ASC 740 and balance sheet purposes, the 10-year recapture rule creates a contingent tax liability that must be assessed at each reporting date. A company that has taken a Section 168(n) deduction must evaluate at each period-end whether any circumstances exist that would indicate the qualifying use may be discontinued within the 10-year window. Under ASC 450-20, if it is probable that the qualifying use will cease and the recapture amount can be reasonably estimated, a tax contingency must be recorded.
More commonly, the 10-year recapture risk affects strategic planning rather than balance sheet accounting during the 10-year period. A company that elects QPP treatment on a $100 million facility and then sells the facility or converts it to non-production use within 10 years faces a recapture tax liability at ordinary income rates on the full $100 million, producing a tax cost of $21 million. This is a real exit cost that must be reflected in any sale or restructuring analysis during the recapture window.
QPP is not eligible for a Section 1031 exchange to the extent of the recapture amount, which eliminates a common real estate exit strategy for companies that might otherwise want to defer gain on a facility sale. Companies that anticipate a facility sale or restructuring within 10 years should model the QPP election with and without the recapture cost before making the election.
What Questions Should Your CFO Ask Before Breaking Ground?
Six questions that should be answered before a company begins construction on a facility it intends to designate as QPP.
Is our primary activity a qualified production activity with substantial transformation? If the company's operations involve packaging, repackaging, distribution, warehousing of finished goods, research, or software development as the primary function of the new facility, QPP is not available. The threshold question is whether the core activity meets the QPA definition and involves substantial transformation.
What percentage of the planned facility will be production space versus offices, parking, and other ineligible uses?If the answer is above 95%, the entire facility can be elected as QPP without allocation. If below 95%, a space-based allocation must be performed. The planned facility layout should be evaluated against the eligibility rules before the building is designed, not after it is built.
What is the construction start date and can it be confirmed using the Section 168(k) rules? The physical work of significant nature test requires real construction activity, not site planning or financing. Confirm with the general contractor exactly when significant physical work will begin, and document that date with dated photographs, construction permits, and contractor invoices.
What are the state tax implications? Most states have not automatically conformed to the Section 168(n) deduction. A full $100 million federal deduction in year one may produce no state tax benefit in states that decouple from federal bonus depreciation or that require 39-year depreciation for buildings regardless of federal treatment. The effective combined federal and state tax benefit of the election should be modeled by state before the election is made.
Is the company subject to ADS for this property? If the company has made a real property trade or business election under Section 163(j) to preserve interest deductibility, the resulting ADS requirement for nonresidential real property eliminates QPP eligibility. Evaluate whether the interest deduction benefit of the Section 163(j) election outweighs the QPP deduction benefit before breaking ground.
What is the probability that this facility will be sold or converted to non-production use within 10 years? If there is a meaningful probability of a strategic transaction involving the facility within the recapture window, model the recapture cost as an exit cost in the transaction analysis. A QPP election that produces $21 million in current tax savings but creates a $21 million ordinary income recapture on a sale five years later provides no net benefit and may increase total tax cost due to state tax non-conformity and the loss of the Section 1031 option.
Frequently Asked Questions
What is Section 168(n) Qualified Production Property?
Section 168(n) of the Internal Revenue Code, added by the OBBBA on July 4, 2025, provides a 100% special depreciation allowance for qualified production property (QPP) in the year the property is placed in service. QPP is nonresidential real property used as an integral part of a qualified production activity (manufacturing, agricultural production, chemical production, or refining) that results in a substantial transformation of a qualified product. IRS Notice 2026-16, issued February 20, 2026, provides interim guidance that taxpayers can rely on until proposed regulations are issued.
Can I deduct a factory building 100% in year one?
Yes, if the property qualifies as QPP and the election is made on a timely filed return for the year the property is placed in service. The entire unadjusted depreciable basis of the qualifying portion of the building, excluding land and ineligible spaces such as offices and parking, can be deducted in year one. A 10-year recapture rule applies if the facility ceases to be used in a qualified production activity.
What is a qualified production activity under Section 168(n)?
A QPA is manufacturing (materially changing the form or function of property to create a new item), agricultural production (raising crops or livestock), chemical production (synthesizing chemical compounds), or refining (improving the grade, quality, or purity of a material). The activity must result in a substantial transformation of a qualified product (tangible personal property held for rent, lease, or sale). Packaging, distribution, research, software development, and engineering activities are not QPAs.
What is the construction start deadline for QPP?
Construction must begin after January 19, 2025, and before January 1, 2029. The notice uses the Section 168(k) rules for when construction begins: physical work of significant nature must start, or the taxpayer must have paid or incurred more than 10% of the total cost of the property under the safe harbor. The property must be placed in service before January 1, 2031.
What happens if we stop using the facility for production?
If the QPP ceases to be used as an integral part of a qualified production activity within 10 years of being placed in service, the prior Section 168(n) deduction is fully recaptured as ordinary income (Section 1245) in the year of cessation. The 10-year clock runs from the placed-in-service date. Partial cessation of qualifying use triggers proportional recapture.
Key Takeaways
- Section 168(n), added by the OBBBA on July 4, 2025, allows a 100% first-year depreciation deduction for qualified production property placed in service in the US after July 4, 2025, and before January 1, 2031. IRS Notice 2026-16, issued February 20, 2026, provides interim guidance that taxpayers can rely on now.
- QPP is nonresidential real property used as an integral part of a qualified production activity: manufacturing, agricultural production, chemical production, or refining. The activity must result in a substantial transformation of a qualified product (tangible personal property held for rent, lease, or sale).
- Section 168(n) fills the gap that Section 168(k) bonus depreciation could not: the building itself and its structural components. Equipment and personal property in the same facility continues to use Section 168(k). Cost segregation studies remain relevant for identifying personal property and 15-year components.
- Ineligible space (offices, parking, finished goods storage, sales, R&D, engineering) cannot be included in QPP. If 95% or more of a building's physical space satisfies the integral part requirement, the entire facility can be elected as QPP without allocation. Below 95%, space-based allocation is required. Headcount is not an acceptable allocation method.
- Construction must begin after January 19, 2025, and before January 1, 2029. The property must be placed in service before January 1, 2031.
- The QPP election is made on a timely filed original return for the year of placement in service and is essentially irrevocable. Revocation requires IRS consent granted only in extraordinary circumstances.
- A 10-year recapture rule converts the prior Section 168(n) deduction to Section 1245 ordinary income if the facility ceases qualifying use within that window. QPP is not eligible for Section 1031 exchange to the extent of the recapture amount, which eliminates a common exit strategy for real estate.
- Companies subject to ADS for nonresidential real property because of a Section 163(j) real property trade or business election are ineligible for Section 168(n). State tax conformity varies; most states have not adopted the QPP deduction.
