February 2026 brought a major development for tax professionals serving manufacturing, agricultural, chemical, and refining clients: the IRS released Notice 2026-16, providing interim guidance on the new 100% special depreciation allowance for qualified production property (QPP) under
§168(n)
, as enacted by the One, Big, Beautiful Bill Act (OBBBA). This is not just another tweak to bonus depreciation—it’s a temporary, potentially game-changing opportunity for full expensing of certain nonresidential real property. Here’s what you need to know to advise your clients and prepare for compliance.
Why Did the IRS Issue Notice 2026-16?
Congress created
§168(n)
to spur domestic investment in production facilities by allowing a 100% first-year depreciation deduction for certain real property used in qualifying production activities. The law applies to property placed in service after July 4, 2025, and before January 1, 2031. However, the statutory language left many practical questions unanswered:
- What exactly is a “qualified production activity”?
- How do you allocate basis between qualifying and non-qualifying portions of a building?
- What are the consequences if the property’s use changes?
Notice 2026-16 provides interim answers, clarifies definitions, and outlines compliance steps. Taxpayers may rely on the notice until proposed regulations are issued, provided they follow it in its entirety
What Qualifies as Qualified Production Property (QPP)?
QPP is not a blanket deduction for all nonresidential real property. Instead, it is the portion of any nonresidential real property that meets all of the following criteria:
- MACRS Property: The property must be depreciable under the Modified Accelerated Cost Recovery System (MACRS).
- Integral Part of a Qualified Production Activity: The property (or portion thereof) must be used as an integral part of a qualified production activity (QPA).
- Location: The property must be placed in service in the United States or a U.S. territory.
- Original Use: The original use must begin with the taxpayer.
- Construction Window: Construction must begin after January 19, 2025, and before January 1, 2029.
- Placed in Service Window: The property must be placed in service after July 4, 2025, and before January 1, 2031.
- Not Subject to ADS: The property cannot be subject to the alternative depreciation system (ADS).
- Timely Election: The taxpayer must designate the property as QPP in a timely election attached to the tax return for the year the property is placed in service
Exclusions: Office space, administrative areas, parking, lodging, sales areas, research, software development, and other non-production functions are explicitly excluded. Taxpayers must allocate the unadjusted depreciable basis between eligible and ineligible portions using a reasonable method—such as square footage, cost segregation, or architectural plans. Employee headcount or time allocation is not considered reasonable
What Is a Qualified Production Activity (QPA)?
A QPA is defined as the manufacturing, production, or refining of a qualified product that results in a substantial transformation of tangible personal property. The notice provides detailed definitions and examples:
- Manufacturing: Requires a material change in form or function, creating a new and distinct item (e.g., steel rods to bolts, wood pulp to paper). Simple packaging, labeling, or minor assembly does not qualify.
- Refining: Includes processes such as petroleum distillation, metal purification, and similar activities.
- Agricultural Production: Covers cultivating crops and raising livestock, but not activities like food marketing or raising non-livestock animals.
- Chemical Production: Involves chemical processes that create new substances from raw materials.
Essential and Related Activities: Activities essential to the QPA (such as storage of raw materials within the same facility) are included, but storage of finished goods is not. Oversight, quality control, and management activities are included only if they occur within the same property or integrated facility and not in excluded areas
Practical Example: A tomato sauce factory qualifies for QPP treatment for its core processing and ingredient storage areas, but not for finished goods storage or office space. The notice’s examples help clarify the boundaries of “integral part” and “substantial transformation.”
Election and Compliance Details
How to Elect QPP Treatment:
- The election must be made on a timely filed original tax return (including extensions) for the year the property is placed in service.
- Attach a statement titled “STATEMENT PURSUANT TO SECTION 7 OF NOTICE 2026-16” that includes:
- Taxpayer name and ID
- Property address and description
- Total unadjusted depreciable basis
- Basis allocated to eligible property (if less than the whole)
- Amount designated as QPP
- Declaration if using the de minimis rule (if 95% or more of the property is QPP)
- Declaration if using the disaster area extension
Revocation: Once made, the election is irrevocable except with IRS consent, which will be granted only in extraordinary circumstances.
Coordination with Other Depreciation Provisions:
- QPP is treated as a separate class of property.
- Electing QPP treatment under
§168(n)
means the 100% deduction is claimed under this provision, not under
§168(k)
bonus depreciation.
- QPP cannot be depreciated under ADS.
- If only part of a property qualifies, the taxpayer must allocate basis accordingly and may use more than one reasonable allocation method if needed
Recapture Risk: The 10-Year Lookback
Beware the recapture provision: If, within 10 years of being placed in service, the property (or a portion) ceases to be used as an integral part of a QPA and is used for another productive purpose, the special recapture rule applies:
- The prior
§168(n)
deduction is recaptured as
§1245
ordinary income in the year of change.
- The taxpayer’s basis in the property is increased by the recaptured amount, and depreciation resumes as if the property were newly placed in service.
- The recapture applies to the portion of the property that changes use, and the taxpayer must use a reasonable method to determine the affected portion Example: If a factory is converted to warehouse space five years after being placed in service, the portion of the building no longer used in production triggers recapture of the original 100% deduction as ordinary income, and future depreciation is based on the new adjusted basis.
Practical Takeaways for Tax Preparers
- Review client portfolios: Identify clients with planned or ongoing construction of nonresidential real property for production activities. Early planning is critical to maximize the benefit.
- Document activities and allocations: Maintain detailed records of facility use, basis allocation, and the rationale for any allocation methods.
- Coordinate with cost segregation specialists: Properly distinguishing between eligible and ineligible property is essential for compliance and audit defense.
- Monitor for changes in use: Implement procedures to track property use for 10 years post-placement to manage recapture risk.
- Stay tuned for regulations: The IRS has requested comments and will issue proposed regulations. Be prepared to adjust compliance as new guidance emerges.
Conclusion
The new
§168(n)
special depreciation allowance for QPP is a powerful, but complex, incentive for domestic production investment. Tax professionals must carefully navigate the eligibility, allocation, election, and recapture rules to ensure clients maximize benefits and avoid costly surprises. Notice 2026-16 is the current roadmap—follow it closely, and watch for further developments
