Background & Legislative Context
- 168 was amended to add §168(n) with the enactment of The One Big Beautiful Bill Act (OBBBA) on July 4, 2025. This section was introduced to encourage domestic manufacturing and production. It allows immediate expensing of QPP. Thus, this provision can provide significant tax cash flow savings when compared to the traditional 39-year depreciation period that normally applies to real property.
Definition of QPP
QPP is defined as nonresidential real property:
- That is MACRS property (i.e., depreciable under §168)
- That is used as an integral part of a qualified production activity (QPA)
- That is placed in service in the United States or its territories
- Original use of which commences with the taxpayer
- The construction of which begins after January 19, 2025, and before January 1, 2029
- That the taxpayer designates as QPP by election
- That is placed in service after July 4, 2025, and before January 1, 2031
- That is not property to which ADS applies
- Is not ineligible property (any portion used for offices, administrative services, lodging, parking, sales, research, software development, engineering, or other functions unrelated to a QPA)
The assessment of whether property is QPP is made at the unit of property level. For instance, each separate building, and improvement or addition, are separate units of property.
Taxpayers may use any reasonable method (other than employee headcount or employee time spent on QPA) to allocate basis of a property between eligible (QPP) and non-eligible property.
Integral Part of a QPA
To qualify as QPP, a QPA must be conducted in, or take place in, the physical space of the property or within a portion of the physical space of the property (in which case, only the portion of the property where the QPA occurs meets this requirement). The Notice provides for a 95% de-minimis rule, under which the entire property meets the integral part of a QPA test if 95% or more of the physical space of the property meets the requirements of the test. The 95% de minimis rule is elective and is made through a declaration included in the election statement. Generally, lessors are not treated as meeting the integral part of a QPA requirement with respect to leased property. Exceptions exist for property leased to a member within the same consolidated group or between pass-through entities under common control (50% or more).
Definition of QPA
QPA means the manufacturing, production (including chemical production and agricultural production), or refining that results in substantial transformation of property comprising a qualified product. Substantial transformation is the result of manufacturing, processing, or refining constituent elements, raw materials, or subcomponents into a final, complete, and distinct item of property that is fundamentally different from the original inputs. For instance, the conversion of wood pulp to paper constitutes substantial transformation, where assembly of gift baskets does not. QPA includes essential activities (including receiving and storage of raw materials) that are not QPA by themselves, but without them, QPA could not occur or would result in a different end product or quantity of qualified product. QPA may also include activities such as production oversight and management, material or vendor selection, development of product design, and similar activities. A safe harbor rule applies for QPP placed in service in 2025 if the taxpayer listed a qualifying NAICS code as the principal business activity on their most recently filed federal income tax return.
Making the Election
Taxpayers must affirmatively make the §168(n) election with respect to QPP by attaching a statement on a timely filed return. The election is irrevocable for that tax year.
Depreciation Recapture Rules
A QPP change in use results in property becoming disqualified property. Disqualified property is subject to depreciation recapture under §1245 as of the beginning of the year in which the QPP change in use occurs. Mechanically, the recomputed basis of the disqualified property or portion thereof (generally, the unadjusted depreciable basis) over the adjusted basis of the disqualified property is recaptured as ordinary income. The disqualified property’s adjusted basis is increased by the amount of §1245 recapture under this rule. The disqualified property is treated as a new asset placed in service as of the beginning of the year of the QPP change in use and is depreciated under §168 (generally over 39 years).
A QPP change in use occurs when the QPP, or a portion thereof, ceases to satisfy the integral part requirement AND is used by the taxpayer in another productive use. Note that a QPP change in use occurs when a lessor, relying on either the consolidated group or controlled group exceptions discussed above, no longer qualifies for the exceptions (because, for instance, the lessee and/or lessor left the consolidated group or are no longer part of the same controlled group).
Reliance & Applicability
Taxpayers may rely on Notice 2026‑16 until proposed regulations are issued. The IRS is soliciting comments for further refinement, with comments due by April 20, 2026.
Key Takeaways
The notice provides taxpayers with further clarification on Treasury and IRS’ view on certain aspects of §168(n). Of course, many questions remain. Taxpayers are encouraged to provide comments to help shape Treasury and IRS’ drafting of Proposed regulations.
- 168(n), along with other business tax provisions enacted as part of OBBBA, such as expansion of bonus depreciation and changes to business interest expense and research and experimentation expenditures, have the potential to provide significant tax savings. However, it’s important to model out how these various provisions may interact with each other and with other aspects of the taxpayer’s situation, including the impact on loss and credit carryovers, and special deductions. The state tax impact of these changes also warrant consideration. States may conform to the Internal Revenue Code automatically or as of a defined date, and they may separately enact provisions that “decouple” from federal treatment. This is quite common for bonus depreciation, for instance. The states may take time to enact legislation that addresses §168(n) and other OBBBA provisions, so the situation today may be different than it is later this year when the 2025 tax return is filed. It is important to monitor developments in the taxpayer’s significant states to reduce the likelihood of an unwelcome surprise.
Notice 2026-16 clarifies key operating rules for §168(n), but the benefit is only realized with disciplined implementation. As for the next steps, taxpayers should:
- Confirm QPP eligibility (including space/use allocations and integral-part support);
- Prepare the election statement and attach it to the timely filed return (including extensions);
- Model interactions with other OBBBA provisions and the impact on loss/credit carryovers and special deductions;
- Run a state conformity check, since many states decouple from depreciation and may adopt separate rules for §168(n);
- Plan early to determine the appropriate reasonable allocation method, as the unit of property framework, space use allocation requirements, and interaction with traditional depreciation rules may necessitate a detailed, engineering-based analysis to support QPP.
This approach helps preserve the intended cash-tax benefit while reducing the risk of federal- or state-level surprises as 2025 return positions are finalized.
If you have any questions or are interested in learning more, we are here to help. Please do not hesitate to reach out to discuss your specific situation.
This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute, an accountant-client relationship.
This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute, an accountant-client relationship.
