Section 168(n) Qualified Production Property After the 2025 Legislation: 100 Percent Expensing for Factory Buildings, the Election and Recapture

Section 70307 of Public Law 119-21 added section 168(n), a special allowance that lets a taxpayer deduct 100 percent of the adjusted basis of qualified production property (QPP) in the year it is placed in service. QPP is the part of a nonresidential building used as an integral part of manufacturing, production or refining. Buildings normally depreciate over 39 years, so this is a first-year write-off of the factory floor itself. Notice 2026-16, announced February 20, 2026 and published in Internal Revenue Bulletin 2026-11, supplies interim rules the IRS says taxpayers may rely on until proposed regulations arrive.

The allowance is an election with tight windows, a statement filed with the return, and a recapture rule if the building stops serving production within 10 years. Each of those points needs a file note before the return goes out.

What qualifies as qualified production property?

Section 168(n)(2)(A) covers the portion of nonresidential real property that meets six conditions:

1. It is used as an integral part of a qualified production activity.
2. It is placed in service in the United States or a possession.
3. Its original use begins with the taxpayer.
4. Its construction begins after January 19, 2025 and before January 1, 2029.
5. It is designated in the election.
6. It is placed in service before January 1, 2031.

The statute adds that a lessor's property used by a lessee does not count as used by the lessor, and the notice has lessor rules in section 4.02(3).

Notice 2026-16 adds that the property must be placed in service after July 4, 2025 (section 4.01(7)). For construction start, it applies rules consistent with Treas. Reg. 1.168(k)-2(b)(5)(iv)(B), including that regulation's safe harbor (section 4.05).

Used property can qualify. Under section 168(n)(2)(B), the original-use and construction requirements are treated as met for acquired property that was not used in a qualified production activity by anyone from January 1, 2021 through May 12, 2025 and that meets the section 179(d) purchase tests. The notice repeats the January 1, 2021 to May 12, 2025 look-back in section 4.06.

What is a qualified production activity?

Section 168(n)(2)(D) defines it as the manufacturing, production or refining of a qualified product, but only if the activity results in a substantial transformation of the property comprising the product. Production is limited to agricultural and chemical production (section 168(n)(2)(E)). A qualified product is tangible personal property, excluding food or beverages prepared in the same building as the retail establishment where they are sold (section 168(n)(2)(F)).

Notice 2026-16 defines substantial transformation as further manufacturing, production or refining of inputs into a final, complete and distinct item that is fundamentally different from those inputs (section 5.02(9)). Grouping and packaging finished goods does not qualify, and the definition applies only under section 168(n). Essential and related activities can be part of the production activity, but storage of finished products is not essential, so that space is ineligible.

Which parts of the building are excluded?

Section 168(n)(2)(C) excludes portions used for offices, administration, lodging, parking, sales, research, software development or other functions unrelated to manufacturing, production or refining. Under the notice's integral-part rule, a building meets the test if a qualified production activity is conducted in, or takes place within, its physical space, and only that portion qualifies (sections 4.01(2) and 4.02).

There is a de minimis rule. If 95 percent or more of the space qualifies, the taxpayer may elect to treat all of it as qualifying (section 4.02(2)). Example 2 in section 4.12 applies it to a building with 5 percent non-qualifying space.

For allocating basis, any reasonable method may be used, such as square footage, cost segregation data, plans or construction invoices. Headcount or employee time is not a reasonable method (section 4.08(1)). Dual-use infrastructure can be allocated using plans or product specifications that reflect actual or planned usage (section 4.08(2)).

How does the election work?

The election is made by the due date, including extensions, of the original return for the year the property is placed in service (notice section 7.01). The taxpayer attaches a statement titled "STATEMENT PURSUANT TO SECTION 7 OF NOTICE 2026-16" to the return (section 7.02). The statement lists:

• The taxpayer's name and TIN
• The property's address and description
• Total unadjusted depreciable basis
• The eligible portion
• The dollar amount designated as QPP
• Any de minimis or disaster-extension declarations that apply

The election specifies the property and the portion designated. Under section 168(n)(6)(B) it is irrevocable except with the consent of the Secretary, granted only in extraordinary circumstances. Section 168(n)(4)(A) treats QPP as a separate class of property and deems the election made for subsections (k)(7), (l)(3)(D) and (m)(2)(B)(iii). Property under the alternative depreciation system is excluded (section 168(n)(4)(B)). For the alternative minimum tax, the deduction is computed without the section 56 adjustment (section 168(n)(3)).

What does a computation look like?

Worked example. A manufacturer completes a 100,000 square foot plant in 2027, with construction having begun in 2025. Unadjusted depreciable basis of the building is $25,000,000. Of the floor area, 96,000 square feet is production space and 4,000 square feet is offices.

• Without the de minimis rule, square footage allocation gives 96 percent x $25,000,000 = $24,000,000 designated as QPP and a first-year allowance of $24,000,000. The remaining $1,000,000 stays on the regular 39 year schedule.
• With the de minimis rule: 96,000 / 100,000 = 96 percent, which is 95 percent or more. The taxpayer may elect to treat the whole building as qualifying and designate $25,000,000.

The statement attached to the return must show the number the client chose, with the square footage schedule behind it.

What happens if the use changes?

Under section 168(n)(5), if within 10 years after the property is placed in service it stops being used as an integral part of a qualified production activity and is put to a different productive use, section 1245 treats it as disposed of at the first change in use. Notice 2026-16 section 8 adds the mechanics:

• The disqualified property is treated as disposed of, and the excess of recomputed basis over adjusted basis is ordinary income in the year of change (section 8.02).
• Basis increases by the gain recognized, and depreciation restarts as a new asset placed in service on the first day of the year of change (sections 8.03 and 8.04).
• Recomputed basis equals the designated QPP basis multiplied by the percentage that changed use, so partial changes are allowed (section 8.05(1)).
• Temporarily idle property is not a change in use (section 8.01(1)(d)).

Continuing the example, assume the plant was expensed on $24,000,000 and in year 6 the whole production area converts to warehouse and distribution. Adjusted basis in the designated portion is zero, so recomputed basis of $24,000,000 minus zero gives $24,000,000 of ordinary income in that year. That basis then depreciates again as a new asset.

What should the file contain?

1. A construction start record (contract, permits, physical work or safe harbor evidence) dated after January 19, 2025.
2. A placed-in-service date supported by a certificate of occupancy or equivalent.
3. A floor plan with square footage by use and the allocation method chosen.
4. A product and process description that shows substantial transformation.
5. The election statement, prepared with the return.
6. A 10 year monitor for change in use.

See Section 179 and bonus depreciation after the 2025 legislation for the ordering with other expensing provisions, depreciation schedules and MACRS, and PP&E capitalization under ASC 360 for how the book treatment differs from the tax allowance. For a client making a plant, the manufacturing audit guide covers the production side.

CORAA prepares ready-to-review audit files for US CPA firms; see /us.

Sources

• Cornell Law School Legal Information Institute, 26 U.S.C. 168, subsection (n): https://www.law.cornell.edu/uscode/text/26/168
• Internal Revenue Service, Internal Revenue Bulletin 2026-11 (Notice 2026-16): https://www.irs.gov/irb/2026-11_IRB
• Internal Revenue Service, Treasury and IRS issue guidance on special depreciation allowance for qualified production property: https://www.irs.gov/newsroom/treasury-irs-issue-guidance-on-special-depreciation-allowance-for-qualified-production-property-announce-upcoming-proposed-regulations-under-the-one-big-beautiful-bill
• U.S. Government Publishing Office, Public Law 119-21 (table of contents, section 70307): https://www.govinfo.gov/content/pkg/PLAW-119publ21/html/PLAW-119publ21.htm

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