Business Tax Update: IRS Guidance on QPP Depreciation Rules

Under the One Big Beautiful Bill Act (OBBBA), eligible businesses can claim 100% first-year depreciation for nonresidential real estate that's classified as qualified production property (QPP). This provision can accelerate depreciation deductions and potentially reduce tax obligations for businesses that invest in qualifying property. However, it's available for a limited time only.

Earlier this year, in Notice 2026-16, the IRS issued interim guidance on the QPP rules. Taxpayers may rely on it until proposed regulations are issued. Let's take a look at some of the many points addressed in the guidance.

What's QPP?

QPP refers to a nonresidential real property, or a portion thereof, that meets the following criteria:

• The property would otherwise be depreciated under the Modified Accelerated Cost Recovery System.
• The taxpayer must use it as an integral part of a qualified production activity (QPA).
• It must be placed in service in the United States or a U.S. territory.
• Its original use must commence with the taxpayer.
• Its construction must begin after January 19, 2025, and before January 1, 2029.
• It must be placed in service after July 4, 2025, and before January 1, 2031.
• The taxpayer must designate the property as QPP by making an election.

QPP generally applies to manufacturers, certain agricultural producers and similar businesses, but only to the portions of property directly used in QPAs.

A taxpayer can designate and elect to treat property as QPP by attaching a statement to its federal income tax return for the tax year in which the eligible property is placed in service. The statement must include the taxpayer's name and identification number. In addition, for each affected property, the taxpayer must provide the street address, description, depreciable basis and dollar amount designated as QPP.

Important: A QPP election, and any designation within it, can be revoked only with IRS consent. This is typically limited to extraordinary circumstances.

Integral Part Requirement

QPP satisfies the integral part requirement if a QPA is conducted within the property. If only a portion of the property is used for a QPA, only that portion satisfies the integral part requirement. If 95% or more of a property's space satisfies the integral part requirement, the taxpayer can treat the entire property as QPP.

Property leased to a business that's engaged in a QPA generally isn't considered used by the lessor as an integral part of a QPA. So, lessors generally can't treat buildings as QPP even if lessees use them for QPAs. However, exceptions apply for intercompany leases within consolidated groups and commonly controlled pass-through entities.

What's a QPA?

A QPA involves the manufacturing, production or refining of a qualified product that results in a substantial transformation of the product. A qualifying product generally includes any tangible personal property except a food or beverage prepared in the same building where it will be sold.

Substantial transformation means the further manufacturing, production or refining of constituent elements, raw materials, inputs or subcomponents into a final, complete and distinct item of tangible property that's fundamentally different from the original components. Examples of substantial transformation include converting wood pulp into paper or steel rods into screws. The mere packaging of finished goods doesn't constitute a substantial transformation.

Essential and Related Activities

Activities that don't, in and of themselves, result in a substantial transformation of property can be included in a QPA if they're 1) essential to completion of the qualified product or 2) related to completion of the qualified product but still essential. An activity is considered essential to completion if:

• It occurs within the same property or integrated facility where the substantial transformation takes place, and
• Without it, the substantial transformation couldn't occur.

The receipt and storage of raw materials or other inputs used in a QPA are considered essential activities if conducted on the same property or within the same integrated facility as the QPA. The mere storage of finished products isn't an essential activity.

Related activities conducted within the same property or an integrated facility don't prevent an activity from being a QPA as long as they're performed in connection with the underlying manufacturing, production or refining activity. Examples include oversight, vendor selection, cost management, and product design or intellectual property development. However, any part of a nonresidential real property building that's used for offices, administrative services, lodging, parking, sales, research, software development, engineering or other functions unrelated to the actual manufacturing, production or refining of QPP must be excluded.

When multiple properties are operated as an integrated facility and are physically located on the same or contiguous land, all the properties can be treated as a single unit of property for purposes of satisfying the requirement that the facility must be used as an integral part of a QPA.

Special Exception for Certain Used Property

As stated above, the original use of nonresidential real property generally must commence with the taxpayer for it to be QPP. In other words, it usually must be new property. However, under a favorable exception, used property that's acquired by the taxpayer after January 19, 2025, and before January 1, 2029, can be treated as QPP if:

• The property wasn't used in a QPA by any taxpayer between January 1, 2021, and May 12, 2025,
• The taxpayer didn't use the property before its acquisition,
• The taxpayer didn't acquire the property from a related party or a member of the same controlled group, and
• The property's tax basis wasn't determined by the previous owner's tax basis.

Safe Harbor Rule for Certain Property Placed in Service in 2025

For property placed in service after July 4, 2025, and on or before December 31, 2025, the taxpayer's activity will be treated as a QPA if:

• The principal business activity code shown on its most recently filed federal income tax return filed before February 19, 2026, is an applicable North American Industry Classification System (NAICS) code listed under sectors 31, 32 or 33 (manufacturing) or subsectors 111 (crop production) or 112 (animal production and aquaculture), and
• The activity conducted in the property results in, or is otherwise essential to, the substantial transformation of QPP.

A taxpayer that doesn't have a recently filed federal income tax return because it's filing its first return on or after February 19, 2026, must reasonably determine that its principal business activity code is an applicable NAICS code on its initial return to be eligible for the safe harbor.

Recaptured Income After a Change in QPP Use

If QPP stops being used as an integral part of a QPA and is used in another productive use within 10 years of being placed in service, previous QPP deductions are "recaptured" and treated as taxable ordinary income. However, the IRS doesn't apply this treatment for QPP that's temporarily idle but expected to resume a QPA in the near future. For example, there's no change in use if QPP is temporarily idle for maintenance or upgrades.

Important: Beware of this 10-year ordinary income recapture rule! If it's likely to come into play for a property, consider not making the QPP election for that property.

Shortest Period Available

Before the OBBBA, factory buildings were generally depreciated over 39 years. Special-purpose buildings used for farming, animal production and aquaculture could be depreciated over shorter periods, but 100% first-year depreciation remains the shortest period available.

It can be challenging to identify and allocate costs to portions of buildings that are used in qualifying vs. nonqualifying activities, as well as to navigate other aspects of the QPP rules. If you're planning to build new facilities or upgrade your existing ones, contact your tax advisor for guidance on how to make the most of this potentially valuable tax break and for updates on future IRS guidance.