IRS Provides Initial Guidance on Depreciation Deductions for Qualified Production Property By Joseph C. Leuchter, CPA
The IRS recently issued interim guidance on a provision in the One Big Beautiful Tax Act (OBBBA) that enables taxpayers to claim a temporary first-year 100 percent deduction for the cost of constructing certain factories, manufacturing plants and refinery structures in the U.S. or a U.S. territory.
Generally, the provision applies to a new class of qualified production property (QPP), which the IRS defines as newly constructed nonresidential real property that is an integral part of a qualified production activity (i.e., manufacturing, chemical or agricultural production and refining) that results in the substantial transformation of a “qualified product.” Taxpayers may claim a deduction of up to 100 percent of the unadjusted basis of QPP in the year the property is placed in service – as long as property construction begins after January 19, 2025, and before January 1, 2029, and property is placed in service after July 4, 2025, and before January 1, 2031.
The guidance issued by the IRS in early 2026 brings clarity and further detail to the QPP regulations to help taxpayers claim the deduction to which they may be entitled. They include the following:
Definition of Substantial Transformation
IRS Notice 2026-16 provides more details and examples of circumstances in which manufacturing, production, and refining activities result in a substantial transformation of the property comprising a qualified product and, therefore, qualify for the QPP bonus depreciation deduction. It also discusses an exception to this rule for property that is deemed “essential” to the completion of the Qualified Production Activity (QPA), even if it does not result in a substantial transformation. For example, a manufacturing, production or refining activity is essential to the completion of a QPA if the activity meets the following criteria:
- It occurs within the same property where a substantial property transformation occurs;
- It does not occur within ineligible property; and
- The qualified product’s substantial transformation cannot occur without the activity, or it would result in a different quality product than the intended qualified product, or it would result in a different quantity of the qualified product than intended.
Used Property
Used property may be treated as QPP only when all the following conditions are met:
- The taxpayer acquires and begins construction on the used property after January 19, 2025, and before January 1, 2029.
- The taxpayer did not use the property at any time before the acquisition.
- No other person used the property in a qualifying production activity (QPA) between January 1, 2021, and May 12, 2025; and
- The taxpayer does not acquire the property from certain related parties and controlled groups, for which the taxpayer’s basis carries over from the transferor.
Leased Property
Property a taxpayer leases generally does not meet the “integral part of QPA” requirement and may not qualify for a QPP deduction, unless the lessee is a pass-through entity (i.e., S Corporation or partnership) or a commonly controlled partner (i.e., sole proprietorship or pass-through entity in which 50 percent or more is owned by the same person or group of persons that own 50 percent or more of the lessor pass-through entity for a majority of the taxable year in which the property is placed in service).
Integral Part of QPA Requirement
To qualify as QPP, each unit of a property, including each building, improvement, addition and its structural components, must be used as an integral part of a QPA. This means that QPA is conducted within a single property unit. If the QPA occurs within a portion of a property’s physical space, only that portion satisfies the requirement. However, if 95 percent or more of the physical space of a property satisfies the integral part requirement when the property is placed in service, the taxpayer may elect to treat the entire property as satisfying the integral part requirement.
Another taxpayer-friendly rule included in the provision allows a taxpayer to treat multiple properties operating on the same or contiguous piece of land as a single unit of property.
Property Ineligible for the QPP Deduction
The IRS guidance specifically excludes from the definition of QPP office space and any portion of nonresidential real property used for administrative services, lodging, parking, sales activities, research activities, software development, engineering activities or storage of finished products.
Recapture Rules
If a taxpayer changes the intended use of all or a portion of QPP (i.e., stops using it for a qualified production activity) within 10 years of the date they originally placed the property in service, that portion of the property becomes disqualified and is subject to recapture rules. This may include situations in which a taxpayer converts a portion of manufacturing space into offices or a storage area. Under these circumstances, the taxpayer must treat the disqualified portion of the property previously claimed as a depreciation deduction as being disposed of and report it as ordinary income in the year its use changes.
The QPP bonus depreciation provisions of the OBBBA are complex and require detailed recordkeeping to demonstrate eligibility for the deduction. To ensure taxpayers apply the law correctly and yield the intended tax and cash-flow benefits, consultation with trusted tax advisors is recommended.
About the Author: Joseph C. Leuchter, CPA, is a principal with Baker Tilly x Berkowitz Pollack Brant’s Tax Compliance and Consulting practice, where he works with individuals and businesses, including complex partnerships, to grow wealth and profits while maintaining tax efficiency. He can be reached at the CPA firm’s Miami office at (305) 379-7000 or info@bpbcpa.com.
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