For about six months now, every major CPA firm in the country has published explainers of the One Big Beautiful Bill Act (OBBBA). The headline is a positive one: Section 168(n) allows manufacturers to fully expense the cost of a new production facility in the year it’s placed in service instead of depreciating that cost over 39 years.
For a $90 million building, that’s the difference between a year-one deduction of roughly $2.3 million and a year-one deduction of $90 million.
This benefit analysis isn’t wrong, it’s just incomplete. The federal mechanics are well understood. The defensibility, especially under IRS Notice 2026-16 and proposed regulations still to come, is where most manufacturers are about to discover they planned aggressively and documented loosely.
QPP & The Four-Part Test
Section 168(k) (permanent 100% bonus depreciation, restored by OBBBA) applies to property with a MACRS recovery period of 20 years or less. That covers most production equipment, but not the building itself.
Section 168(n) extends 100% expensing to “qualified production property” (QPP), non-residential real property used as an integral part of a qualified production activity. For property that would otherwise depreciate over 39 years, this is functionally a 39-year-to-1-year compression.
To qualify, the property must meet four tests:
- It must be non-residential real property
- Construction must begin after January 19, 2025 and before January 1, 2029
- Original use must begin with the taxpayer
- The property must be used as an integral part of the manufacturing, production, or refining of qualified products.
The fourth is where many projects fail the test.
Trap 1: Meeting the “Substantial Transformation” Definition
The qualified production activity test requires that the production activity result in a “substantial transformation” of input materials. IRS Notice 2026-16 has provided the framework for how that standard applies, drawing from concepts the IRS developed under the former Section 199 domestic production activities deduction. What remains fact-specific is how each facility’s actual production activity measures against it.
The QPP-eligible position is defensible for facilities where raw materials are transformed in identifiable ways: cutting, welding, chemical processing, metallurgical changes, precision machining, food processing involving cooking or chemical change, refining. The position is much harder for facilities where inputs and outputs are recognizably the same components in different configurations.
The documentation that supports the position needs to be built during construction, not reconstructed in audit. Production process diagrams, input/output specifications, and engineering descriptions of the transformation that occurs on each major equipment line are what an examining agent will look at first.
Trap 2: Partial-Use Allocations
Section 168(n) explicitly excludes the portion of a building used for offices, administrative space, sales activities, research and development, and other functions unrelated to production. On a typical advanced manufacturing facility, that exclusion can carve 10–25% of the total square footage out of QPP, and the carve-out must be allocated on a defensible basis, not estimated.
Notice 2026-16 provides a safe harbor here. If 95% or more of a building’s physical space is used for qualified production, the taxpayer can elect to treat the entire property as QPP and skip the allocation exercise entirely. For facilities that are purpose-built production buildings with minimal office footprint, that threshold is worth modeling early. For facilities below 95%, the allocation becomes a required and documented part of the QPP position.
This is where engineering-based cost segregation methodology diverges from the federal tax depreciation models most companies start with. A standard cost seg study allocates between long-life (39-year) and short-life (5/7/15-year) property. A QPP-aware study has to make a second cut: within the 39-year residual, which portion is qualified production space and which portion is non-qualifying?
Mezzanine offices over a production floor, quality lab space adjacent to the line, shipping and receiving areas. Each of these gets analyzed on the specific facts of how the space is used, and the documentation has to support the percentage allocation that flows through to the deduction.
Trap 3: The 10-Year Recapture Rule
If the property ceases to be used in a qualified production activity within ten years of being placed in service, some portion of the QPP deduction may be recaptured. The recapture can be triggered by sale, change of use, conversion to non-production purposes, or material change in the business activity at the facility.
For manufacturers that fully expect to operate the facility for the long term, this is not a problem. For manufacturers contemplating sale-leaseback transactions, partial divestitures, or strategic flexibility around the facility’s future use, the recapture rule is a real consideration. So is M&A — a buyer acquiring the facility within the 10-year window inherits the recapture exposure, which can affect valuation.
The recapture rule also means QPP can’t be treated as free money against a future strategy that might shift. The deduction is closer to a 10-year commitment to operating the facility for its qualified purpose.
Trap 4: Missing the Election Window
The QPP deduction requires an affirmative election made on the tax return for the year the property is placed in service. Under Notice 2026-16, that election is irrevocable once the return is filed. A manufacturer that misses it for a given property cannot go back and claim it later, regardless of whether the facility clearly qualified.
For a large facility placed I service late in a tax year, the window between placed-in-service date and return filing can be surprisingly short. If the cost segregation study isn’t complete, the QPP-eligible square footage hasn’t been allocated, and the production activity analysis hasn’t been documented, the company faces a choice: file without adequate support or miss the election entirely. Neither is a good outcome.
This is the trap that catches companies who treat QPP as a tax filing exercise rather than a project planning exercise. The analysis that supports the election, production activity documentation, space allocation, construction cost detail, and placed-in-service confirmation needs to be substantially complete before the return deadline, not assembled afterward.
Recommended approach
For facilities currently under construction or in design, the strategy is straightforward:
- Confirm QPP eligibility as a threshold matter – facility use, NAICS, planned production activity, whether the construction calendar fits inside the January 20, 2025 to January 1, 2029 commencement window, and whether the facility will be placed in service before January 1, 2031.
- Engage a QPP-aware cost segregation team during construction, not after the fact – the documentation rigor required is materially higher than a traditional cost seg study, and reconstructing it after placed-in-service is harder and more expensive.
- Model the 10-year recapture risk – calculate the risk of recapture against the realistic operating horizon of the facility
- Start the cost seg engagement early enough to support the election – the QPP election is irrevocable and must be made on the return for the year the property is placed in service.
Section 168(n) is the most aggressive depreciation provision in the federal tax code. The window to use it on a defensible basis is open through the 2028 construction commencement deadline, with a placed-in-service deadline of January 1, 2031. The projects that capture the full benefit will be the ones that treat it as an engineering exercise rather than a tax filing exercise.
KE Andrews works with capital-intensive manufacturers on integrated cost segregation, property tax, sales and use tax, and credits and incentives engagements. To discuss how the 168(n) framework applies to a specific project, get in touch with our team.
