Beginning of Construction for QPP

As businesses evaluate the new QPP deduction under Section 168(n), which was enacted by the OBBBA, many questions remain – including when construction begins for purposes of determining which projects are eligible. This issue is especially important for taxpayers with major capital expenditures for manufacturing, refining, or production that began construction in late 2024 or early 2025, as their project timelines could determine whether they can take advantage of the significant new deduction under Section 168(n).

While the IRS has not yet issued specific guidance for Section 168(n), existing authorities – including rules applicable to certain energy credits and rules under Treasury Regulation Section 1.168(k)-2 for bonus depreciation – provide potential frameworks for how the U.S. Department of the Treasury and the IRS might approach the definition of “beginning of construction.”

Background

Section 168(n) allows companies to immediately expense the portions of nonresidential real property used as an integral part of U.S.-based manufacturing, refining, agricultural production, or chemical production of a qualified product. For activities to qualify as manufacturing, production, or refining of a qualified product, they must result in a substantial transformation of the property comprising the product. The QPP deduction is not available to lessors of otherwise eligible property. If the property’s use changes to an ineligible use within a 10-year period, recapture rules apply.

The QPP deduction is temporary and retroactive. QPP expenditures are eligible for the deduction only if construction begins after Jan. 19, 2025, and before Jan. 1, 2029, and the property is placed in service after July 4, 2025, and before Jan. 1, 2031. Thus, the definition of “beginning of construction” is key to eligibility for the deduction on Section 168(n)’s effective date.

What counts as “beginning of construction”

Although Treasury and the IRS have not yet issued guidance defining “beginning of construction” for purposes of Section 168(n), taxpayers evaluating whether particular projects qualify for the deduction can look to other analogous areas of the IRC, such as rules applicable to energy credits and bonus depreciation. While the approaches taken for energy credits and bonus depreciation are not the only possible methods Treasury and the IRS might take, they are reasonable approaches that could be adopted or adapted for purposes of Section 168(n).

Baseline standard: Physical work of a significant nature

Treasury and the IRS could use a physical work standard similar to the one used for energy credits (including credits under Sections 45 and 48) and Treasury Regulation Section 1.168(k)-2 to determine beginning of construction under Section 168(n). That standard treats construction as having begun when physical work of a significant nature starts. This work can occur on-site or off-site and can be performed by the taxpayer or by another party under a written binding contract.

Examples of activities that generally qualify under this standard include:

• Excavation for foundations or footings
• Setting anchor bolts or pouring concrete pads
• Off-site fabrication of major components under a binding contract

Activities that typically do not qualify as work of a significant nature include planning, design, permitting, feasibility studies, site clearing unrelated to foundations, and financing activities.

Safe harbor under the energy credit framework

Energy credit rules include a long-standing cost-based safe harbor that Treasury and the IRS might look to when developing guidance for what constitutes “beginning of construction” under Section 168(n). Under that safe harbor, known as the 5% safe harbor, construction is treated as having begun if the taxpayer incurs at least 5% of the total project cost and thereafter makes continuous progress toward completion. All costs properly includible in the depreciable basis of the facility are counted in determining whether the threshold is met.

While recent guidance narrowed the availability of this safe harbor for certain renewable energy property, it remains a well-established framework and a potential model for determining when construction begins for purposes of Section 168(n).

Safe harbor under Treasury Regulation Section 1.168(k)-2 for bonus depreciation

The Treasury Regulation Section 1.168(k)-2 bonus depreciation regulations provide another cost-based safe harbor that could inform the approach Treasury and the IRS take for purposes of Section 168(n). Under that safe harbor, known as the 10% cost safe harbor, construction begins when the taxpayer incurs more than 10% of the total cost of the property, excluding early-stage soft costs such as planning, design, feasibility studies, and architectural work. Costs incurred under a written binding contract are treated as incurred by the taxpayer for this purpose. The Treasury Regulation Section 1.168(k)-2 approach is a more flexible and investment-oriented approach than the physical work standard or the 5% safe harbor.

Looking ahead

Beginning of construction is one of several areas for which additional guidance under Section 168(n) is expected. Other significant issues under Section 168(n) in need of guidance include the definitions of “integral to manufacturing” and “substantial transformation,” the rules for related-party arrangements, including leases, and how to apply the recapture rules.

Crowe observation

Given the number of issues that need to be addressed, it’s uncertain when guidance will be released on any particular topic.

Until guidance is issued on beginning of construction, taxpayers should consider their particular facts and circumstances under the various frameworks that are used in other areas to define “beginning of construction” for planning purposes and be prepared to document construction progress. However, taxpayers should remain flexible. If Treasury and the IRS release guidance on beginning of construction that differs from the definition used by the taxpayer, the taxpayer will have to evaluate the impact of the new rules. Taxpayers with solid documentation of physical work will have an easier time evaluating the impact of the new rules on their project.

Manufacturers, refiners, and producers investing in new facilities should work closely with their tax advisers to understand how their project timelines, documentation, and elections align with the government’s ultimate interpretation of beginning of construction.