The recently enacted One Big Beautiful Bill Act (OBBBA) introduced a game-changing tax incentive for U.S. manufacturers: the Section 168(n) special depreciation allowance. On Feb. 20, 2026, the Treasury and IRS released Notice 2026-16, providing much-needed interim guidance on how taxpayers can claim a 100% immediate deduction for "qualified production property" (QPP) for which construction begins after Jan. 19, 2025, and before Jan. 1, 2029.
For many businesses, this guidance transforms what was previously 39-year real property into an immediate tax write-off, offering a significant boost to cash flow and project ROI.
What is Qualified Production Property (QPP) and Qualified Production Activity (QPA)?
Under the new rules, QPP is generally defined as nonresidential real property (such as factory buildings or integrated facilities) used as an integral part of a Qualified Production Activity (QPA). To qualify, the activity must fall into one of four categories:
- Manufacturing: Materially changing the form or function of tangible personal property to create a new item
- Chemical production: Processing chemical compounds
- Agricultural production: Cultivating crops or livestock
- Refining: Purifying or upgrading raw materials into higher-value products
The IRS emphasizes a "substantial transformation" standard — simple assembly, packaging, or labeling will not suffice to qualify a facility as QPP.
Key Takeaways from Notice 2026-16
1. Substantial Transformation
For a QPA to qualify, it must substantially transform inputs into a final product that is both complete and distinct. The end result should be significantly different from the original materials; for example, turning wood pulp into paper or transforming steel rods into bolts. Merely bundling or packaging finished goods does not satisfy this criterion. Complex assembly operations may also qualify where the final product is materially distinct from its individual parts.
2. The 95% De Minimis Rule
One of the most taxpayer-friendly provisions in the Notice is the "all-or-nothing" rule for mixed-use buildings. Typically, office space, cafeterias, and parking structures are excluded from QPP. However, if 95% or more of a building’s physical space is used for a QPA, the taxpayer may elect to treat the entire building as QPP.
3. Lessor-Lessee Exception
Section 168(n) generally prohibits QPP treatment for property leased to third parties, with two key exceptions as outlined in Notice 2026-16:
- Where the lessee belongs to the same consolidated group as the lessor, the lessee’s utilization of the property within a QPA is ascribed to the lessor.
- Where the lessee and lessor are under common control (that is, more than 50% common ownership), the lessee’s QPA is attributed to the lessor.
These exceptions facilitate standard real estate arrangements — such as operating companies leasing from affiliated property holding entities — to remain eligible for QPP treatment if all other regulatory criteria are fulfilled.
4. Storage and Infrastructure Clarifications
The Notice draws a clear line regarding storage:
- Eligible: Storage of raw materials and inputs used in the production process
- Ineligible: Storage of finished goods held for sale
In addition, the IRS permits taxpayers to divide the costs of "dual-use" infrastructure — like HVAC or sprinkler systems — between qualifying and non-qualifying spaces using any reasonable approach, such as architectural plans or cost segregation studies. However, employee headcount cannot be used as a metric.
5. Strategic Timing and Basis Allocation Requirements
The 100% allowance is not permanent. To be eligible, the property must meet strict timing windows with construction commencing after Jan. 19, 2025, and before Jan. 1, 2029. In addition, QPP must be placed in service after July 4, 2025, and before Jan. 1, 2031.
Taxpayers may use any reasonable method to allocate unadjusted depreciable basis between eligible and ineligible property. Examples include square footage, cost segregation data, or construction invoices.
The notice also confirms that contract manufacturing arrangements do not disqualify a property from QPP treatment. A taxpayer may qualify if it conducts a QPA at the property, even if the taxpayer does not own the product or performs the activity under contract for another party.
6. Election Mechanics and Recapture Risk
The 100% depreciation is elective but irrevocable without IRS consent, which will only be provided under extraordinary circumstances. Taxpayers must affirmatively elect to treat property as QPP on a timely filed tax return.
However, this benefit comes with a “clawback” risk. The Notice establishes a 10-year recapture period. If the property ceases to be used for a qualified production activity (e.g., a factory is converted into a retail warehouse) within 10 years of being placed in service, the taxpayer may be required to recapture the tax benefit as ordinary income. This “clawback” will be gain recognized under IRC Section 1245, the basis increased by that gain, and the recomputed basis being treated as a new separate asset on the first day of the year of change starting a new 39-year recovery period.
Why This Matters for Your Business
Notice 2026-16 provides the practical roadmap businesses have been waiting for since the OBBBA was signed into law to move forward with domestic capital projects. By converting long-term depreciation into an immediate 100% deduction, the after-tax cost of new manufacturing facilities is dramatically reduced.
READ MORE: Depreciation expensing changes in the One Big Beautiful Bill Act