IRS Issues Interim Guidance on 100% Qualified Production Property Deduction (IRC §168(n))

Qualified Production Depreciation Deduction: IRS Issues Key Guidance

The IRS has released Notice 2026-16, providing interim guidance on the new IRC §168(n) qualified production depreciation deduction enacted under OBBBA.

This guidance may be relied upon until proposed regulations are issued and answers several practical questions about eligibility, elections, and recapture.

What Is the Qualified Production Depreciation Deduction?

IRC §168(n) allows a 100% depreciation deduction for certain real property that:

• Is placed in service after July 4, 2025, and before January 1, 2031

• Is used in a qualified production activity

• Meets specific statutory and procedural requirements

This is a full expensing provision for eligible production-related real property — a significant acceleration of cost recovery.

Key Clarifications in IRS Notice 2026-16

1. The 95% Use Test

To qualify, at least 95% of the property’s space must be used in a qualified production activity.

The guidance confirms that:

• The test applies to the property — or a portion of the property

• The space must be an integral part of the production activity

• Mixed-use buildings require careful allocation and documentation

This is a high threshold. Incidental use outside production can jeopardize eligibility.

2. Improvements to Existing Property May Qualify

   
   

The deduction is not limited to newly constructed buildings.

Improvements and additions to existing real property can qualify, provided they meet the production-use requirements.

This opens planning opportunities for businesses expanding or upgrading manufacturing or agricultural facilities.

3. Lessor Rules and the Common Control Exception

Generally, lessors cannot claim the deduction.

However, an exception applies if:

• The lessor and lessee are under common control, or

• They are members of a consolidated group

This distinction is critical for related-party structures and real estate holding entities.

4. Election Flexibility

Taxpayers may elect:

• The entire unadjusted depreciable basis of eligible property, or

• A specified dollar amount (up to the unadjusted basis)

This provides flexibility in managing taxable income and long-term depreciation planning.

5. Simplified Qualification for 2025 Only

For tax year 2025 only, a taxpayer can establish engagement in a qualified production activity if its principal business activity code on the 2025 return falls under:

• NAICS sectors 31, 32, or 33 (manufacturing), or

• Subsectors 111 or 112 (agriculture),

as listed in the 2022 NAICS Manual.

This temporary rule simplifies initial qualification but does not eliminate the need to meet the substantive 95% use requirement.

Election and Recapture

The Notice outlines:

• How the election is made

• Required reporting

• Circumstances that trigger recapture

Improper use changes or failure to maintain qualified production status may require inclusion of previously deducted amounts in income.

Practical Considerations

Businesses considering construction, expansion, or major facility improvements between 2025 and 2030 should:

• Review space allocation carefully

• Document production use percentages

• Analyze entity structure (especially leasing arrangements)

• Coordinate depreciation elections with broader tax planning

Because this provision applies only to real property placed in service within a defined window, timing and documentation are critical.

Qualified Production Property Deduction (IRC §168(n))

Source Credit: IRS Notice 2026-16; summary based on reporting from Spidell’s Tax Update.