The IRS’ recent guidance on the One Big Beautiful Bill Act’s (OBBB) depreciation deduction for qualified production property provides “at least some version of an answer” to most key questions, according to Plante Moran partner Stephen Eckert. However, he highlighted one area where clients might be missing an opportunity to take advantage of the new deduction.
Qualified Production Property Deduction Basics
New IRC § 168(n) allows taxpayers to take a special 100% first‑year depreciation deduction for the qualifying portion of certain new or substantially improved nonresidential real property. To claim the deduction, taxpayers must begin construction after January 19, 2025, and before January 1, 2029, and place the property in service, generally, after July 4, 2025, and before January 1, 2031.
In addition, the property must be used as an integral part of a qualified domestic manufacturing, production, or refining activity. Portions of property that are used for non-production functions, such as administration, parking, sales, and research, must be excluded when claiming the deduction.
Initial Guidance Answers Key Questions
The IRS issued Notice 2026-16 on February 20 to provide initial guidance about the § 168(n) deduction. Eckert told Checkpoint that the clarifications in the recent guidance have allowed businesses to start planning and thinking about how to take advantage of this new deduction.
Overall, the deduction is rooted in historical Tax Code concepts, according to Eckert. “It really is just an expansion of existing depreciation rules” and other existing concepts, he explained. And that’s true for multiple provisions, including those regarding cost allocation and the requirement that the production activity result in a “substantial transformation.”
Allocation
Section 168(n) provides that each portion of the nonresidential property for which the taxpayer claims a deduction must be an “integral part” of the qualified production activity. In allocating basis between eligible and ineligible property, the notice explains that that taxpayer can use “any reasonable method.” It provides examples, including square footage, cost segregation data, architectural or engineering plans, process diagrams, and construction invoices.
“The allocation rules are really just kind of pulling in what we traditionally do with a cost segregation study anyways,” Eckert explained. He finds it very useful that the guidance “basically invites taxpayers to use any reasonable method” to allocate costs. The “open-ended reasonable method” allows taxpayers “to pick and choose what might be a more favorable answer within that realm of reasonableness,” he added.
Substantial Transformation
Notice 2026-16’s provisions on when the substantial transformation of property requirement has been met are another example of where the IRS is “really just reinventing rules that have existed before,” said Eckert. He cited concepts from the § 199 domestic production activities deduction, which “went away” with the 2017 Tax Cuts and Jobs Act.
“Some specific language in the statutory text [of § 168(n)] really is exact language from § 199,” said Eckert. “They’re really just importing this concept” in “trying to draw this line between very limited activity that is really essentially repackaging something, versus actually a manufacturing or production activity to create something new.”
However, despite incorporating these familiar provisions, Eckert expects the IRS will get some “industry pushback.” In particular, he’s concerned about treatment of space used to house finished goods. It’s “pretty common that at the end of a production line you have a space for finished goods,” said Eckert, but that portion of a property is not considered to be used as an integral part of production. And generally, he anticipates stakeholders weighing in on “things that might be left out in the current definitions” related to substantial transformation.
Related-Party Leasing
Eckert called Notice 2026-16’s provisions on related-party leasing “the single most important aspect of this guidance.” He explained that many businesses prefer to lease facilities in closely held scenarios. And it’s “very common” in the manufacturing industry to have the business be held in one legal entity, while investors have a “separate, parallel entity” that doesn’t own real estate.
The lack of clarity after the OBBB on treatment of related parties was “holding up some planning,” said Eckert. Investors and owners have “plenty of reasons” why they may want to own a facility but not the real estate, particularly for C corporations and S corporations, he explained.
The notice clarifies that “if you meet the related-party tests, then the property owner gets to pull in the production activity of the related manufacturer,” Eckert explained. He called this “a game changer” for manufacturing businesses in “closely held scenarios.”
The guidance also specifies that a consolidated group will be treated as a single taxpayer for purposes of § 168(n). Eckert sees that provision as “more expected,” but still “a very helpful clarification.”
The Business Expansion Option
Beyond the recent guidance, Eckert says one point he’s stressing in conversations about § 168(n) with clients is that both “brand new” facilities and the expansion of an existing facility can qualify for the deduction.
“A lot of folks are gravitating towards the idea that I’m going to build a brand-new building, a brand-new facility,” he said. While that’s certainly an option under § 168(n), expanding an existing building “opens the door for many, many more opportunities.”
For many, a $50 million investment in a new facility may not be “palatable,” said Eckert, whereas a $500,000 or $1 million expansion might be more achievable. This “expansionary” option is “a deeper topic” that Eckert is “trying to try to get out there.”
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