Guidance on OBBBA Manufacturing Deduction

On Feb. 20, the IRS released Notice 2026-16, providing interim guidance on the new Section 168(n) depreciation allowance for QPP enacted by the One Big Beautiful Bill Act (OBBBA). The notice defines key terms, explains how to identify and measure the eligible portion of a nonresidential building, provides rules for making the election, and describes when ordinary income recapture applies if the property later stops being used for production. The U.S. Department of the Treasury and the IRS intend to issue proposed regulations consistent with this notice, but taxpayers may rely on the notice in the interim.

Background

Section 168(n) is a temporary incentive aimed at expanding U.S.-based manufacturing, agricultural and chemical production, and refining by allowing a 100% depreciation allowance for QPP. If the property’s use changes to an ineligible use within a 10-year period, recapture rules apply.

The statute defines QPP as the portion of nonresidential real property that is used as an integral part of a qualified production activity (QPA) and that meets the following criteria:

• The property is placed in service in the United States or a U.S. territory.
• Original use of the property commences with the taxpayer, with an exception for acquired property that was not used in a QPA from Jan. 1, 2021, through May 12, 2025.
• Construction of the property begins after Jan. 19, 2025, and before Jan. 1, 2029.
• The property is designated by the taxpayer in an election.
• The property is placed in service after July 4, 2025, and before Jan. 1, 2031.
• The alternative depreciation system under Section 168(g) does not apply to the property.

The statute further provides that QPP does not include the portion of nonresidential real property used for offices, administrative services, lodging, parking, sales activities, research activities, software development or engineering activities, or other functions unrelated to the manufacturing, production, or refining of tangible personal property.

The statute defines QPA to mean the manufacturing, production, or refining of a qualified product. The activities of any taxpayer do not constitute manufacturing, production, or refining of a qualified product unless the activities of such a taxpayer result in a substantial transformation of the property comprising the product.

Notice 2026-16

Because the statute focuses on portions of buildings and on how space is used, taxpayers immediately faced interpretive questions – how to define the relevant unit of property, how to allocate the costs to construct a building between QPP and non-QPP, how to treat mixed-use sites, how to handle leases in controlled structures, and how to administer recapture when use changes. Notice 2026-16 addresses those questions. Additionally, the notice explains Section 168(n) using familiar concepts drawn from the Section 168(k) bonus depreciation rules (for example, original use and construction start standards) so taxpayers can apply a consistent approach.

Crowe observation

The notice definitively answers the beginning of construction question plaguing taxpayers previously.

Highlights of the notice follow.

Eligible space and the unit of property. Only the physical space in which a QPA is conducted (or takes place) satisfies the integral part requirement, so mixed-use facilities must isolate qualifying areas. The notice generally treats each building (including structural components) as a single unit of property and later improvements to the property are treated as separate units. Taxpayers with co-located properties that operate together may elect to treat them as an integrated facility. A de minimis election allows taxpayers to treat an entire property as being used as an integral part of a QPA if at least 95% of the property is used as an integral part of a QPA.

Mixed-use rules and basis allocation. Space used for offices and other nonproduction functions is ineligible to be treated as QPP. The notice distinguishes storage of raw materials used or consumed in the QPA (generally eligible) from storage of finished goods (generally not eligible). Taxpayers can use any reasonable method to allocate unadjusted depreciable basis between eligible and ineligible portions of mixed-use spaces (for example, square footage, cost segregation, or engineering plans). Employee time or headcount is not acceptable. The notice also permits reasonable allocations of depreciable basis for dual-use infrastructure such as HVAC or sprinkler systems.

Definition of a QPA. A QPA is the manufacturing, producing (agricultural or chemical products only), or refining of a qualified product (generally tangible personal property) and must involve a substantial transformation of inputs into a distinct final product. Packaging and minor assembly do not qualify as QPA. Steps that do not themselves create the substantial transformation can be included when they are essential to completion of the QPA and occur in an eligible space. For property placed in service during 2025, taxpayers can use a North American Industry Classification System code safe harbor to establish that the activity is a QPA.

Property leased to related parties. The statute indicates that property used by a lessee is not considered to be used by the lessor as part of a QPA. However, the notice provides relief for certain related-party leases by allowing the lessor to treat the property as being used in a QPA if such property is used in a QPA by the related-party lessee.

Election and coordination. The election is made on a timely filed return (including extensions) for the year the property is placed in service by making a statement identifying the property and the designated dollar amount of QPP. Taxpayers can designate less than the full eligible basis, providing flexibility and potentially reducing exposure if future use changes. The notice also explains coordination with other accelerated depreciation regimes.

Recapture. If QPP ceases to be integral to a QPA within 10 calendar years and is put to another productive use, the affected portion becomes disqualified property and triggers Section 1245 ordinary income recapture based on recomputed versus adjusted basis, with post-change depreciation computed as though newly placed in service.

Looking ahead

Taxpayers pursuing Section 168(n), can use the notice to build their compliance file for supporting the deduction. They should document the construction start date using the rules under the Section 168(k) bonus depreciation regulations and retain records that connect costs to specific eligible areas and structural components. Taxpayers also should map facility space to QPAs and identify spaces that include ineligible uses, choose a reasonable allocation method for depreciable basis, and coordinate any decision to designate less than full eligible basis in the taxpayer’s Section 168(n) election with its broader depreciation strategy.

Taxpayers should consult their tax advisers to track the latest developments and to be ready to adjust documentation if future guidance changes the rules set forth in the notice.