Last year’s One Big Beautiful Bill Act (OBBBA) created a new but temporary special depreciation deduction allowance for qualified production property (QPP). Certain manufacturing related real property placed in service after July 4, 2025 and before January 1, 2031 are eligible. Taxpayers had to depreciate such property over a 39-year period under previous law. This new law under the OBBBA is basically bonus depreciation deduction for certain buildings and production facilities as it allows taxpayers to elect a deduction equal to 100% of the property’s adjusted basis in the tax year it’s placed in service.

In recently issued Notice 2026-16, the IRS provided taxpayers with guidance they can generally rely on until proposed regulations are published. This notice clarifies several important issues related to the depreciation deduction.

Identifying QPP

The guidance defines QPP as any portion of nonresidential real property that is:

• Subject to the Modified Accelerated Cost Recovery System
• Used by the taxpayer as “an integral part” of a qualified production activity (QPA, defined below)
• Placed in service in the United States or any of its territories

 
In addition, the property’s construction must begin after January 19, 2025 and before January 1, 2029. Its original use generally must begin with the taxpayer, though certain used property may qualify as QPP under special rules.

Property (or a portion of property) is used as an integral part of a QPA if the QPA takes place in the physical space of the property (or a portion of the physical space). Each unit of property (including additions and improvements) must satisfy the integral part requirement on its own, with an exception for “integrated facilities.”

Taxpayers can treat multiple properties that operate as an integrated facility on the same piece or contiguous pieces of land as a single unit of property. For example, if a manufacturer constructs a new building to store raw materials and other manufacturing inputs for activities in two factories on the same site, the three buildings constitute a single unit of property for purposes of the integral part requirement.

The guidance also includes a de minimis rule: If 95% or more of a property’s physical space satisfies the integral part requirement when the property is placed in service, the taxpayer can elect to treat the entire property as satisfying the requirement.

For purposes of determining whether property meets the integral part requirement, property used by a lessee generally isn’t considered to be used by the lessor taxpayer as part of a QPA. The guidance provides exceptions, though, for intercompany leases within consolidated groups and commonly controlled pass-through entities.

The guidance specifies several types of ineligible property, including property used for offices, administrative services, lodging, parking, sales activities, research activities, software development or engineering activities, or other functions unrelated to a QPA. Property used to store finished products is also ineligible.

Under the guidance, taxpayers may use any reasonable method to allocate a property’s unadjusted depreciable basis between eligible property and ineligible property. The use of square footage, cost segregation data, architectural or engineering plans, process diagrams, or construction invoices to allocate unadjusted depreciable basis to eligible property may be reasonable methods. Taxpayers can also use any reasonable method to allocate the basis for “dual-use infrastructure” that serves both eligible property and ineligible property (such as an HVAC or sprinkler system).

Identifying QPAs

A QPA is the manufacturing, production, or refining of a qualified product that results in a “substantial transformation” of the qualified product (generally, any tangible personal property except a food or beverage prepared in the same building where it will be sold). The guidance explains that “substantial transformation” refers to the further manufacturing, production, or refining of the constituent elements, raw materials, inputs, or subcomponents into a final, complete, and distinct item of property that’s fundamentally different from those original elements, materials, inputs, or subcomponents.

The guidance interprets the term QPA somewhat broadly. It says that a QPA can include “essential activities” that are critical to the completion of the product (for example, the receiving and storage of raw materials or other inputs to be used or consumed during a QPA). A QPA also includes certain related activities, such as oversight and direction of the manufacturing, production, or refining activities that result in the substantial transformation of a qualified product.

The guidance includes specific definitions for “manufacturing,” “production,” “refining,” and other important terms. Notably, “production” is limited to activities in the agricultural or chemical industries.

That’s Not All

The interim guidance also includes special rules, election procedures, and a safe harbor for property placed in service in 2025 — as well as information about how depreciation deduction must be recaptured and included in ordinary income if a QPP change in use occurs within 10 years after the property is placed in service. We can help you navigate the rules of this new tax break if you’re eligible.