Qualified Production Property: Unlocking 100% Deductions for Manufacturing Facilities

Under previous tax laws, businesses have typically had to depreciate the cost of manufacturing facilities and warehouses over a 39-year period. However, the addition of IRC Sec. 168(n) under the One Big Beautiful Bill Act (OBBBA) provides a 100% deduction for qualified production property (QPP) for purposes of both regular and alternative minimum income tax. While the OBBBA also impacts depreciation for other qualified assets under IRC Secs. 168(k) and 179, IRC Sec. 168(n) specifically targets certain real property additions.

Qualified Production Property Criteria

To qualify as a QPP asset, the property must meet these criteria:

Qualified Use: The property's primary function must be manufacturing, producing, or refining tangible personal property. This includes facilities directly involved in the creation, assembly, or processing of physical goods, emphasizing a "substantial transformation" of the product. For leased property, the lessee’s use does not count toward satisfying the requirement that the taxpayer engage in a qualified production activity. The taxpayer themselves must operate the qualifying activity.

New Construction Requirement: The designation applies to applicable newly constructed buildings and structures and the original use of the property must generally commence with the taxpayer claiming the deduction. While primarily for newly constructed buildings where original use commences with the taxpayer, IRC Sec. 168(n) also includes a special rule for certain existing nonresidential real property if it was not previously used in a qualified production activity for a specified period and meets certain acquisition criteria.

Construction and Service Dates: Construction of the property must be between January 20, 2025, and December 31, 2028. The property must also be placed in service between July 5, 2025, and December 31, 2030. The secretary of the treasury may, in certain extraordinary circumstances, extend the placed in-service date for property whose completion is delayed by an “Act of God,” such as designated natural disasters, etc.

Location Requirement: The property must be placed in service within the United States or any U.S. possession.

Election: To claim this treatment, the taxpayer must designate the nonresidential real property subject to the election on their federal tax return.

Ineligible Property

The property must not be used substantially for the following:

• Office and administrative spaces
• Lodging and parking facilities
• Areas dedicated to sales activities
• Spaces used for research, software development, or engineering functions
• The preparation and sale of food or beverages in the same building as a retail establishment
• Any other functions that are not directly integral to the manufacturing, production, or refining of tangible personal property

Considerations and Pitfalls

Taxpayers should carefully consider the following when making an election under IRC Sec. 168(n):

Depreciation Recapture Rules: Taxpayers should be aware of important recapture rules. If, within a ten-year period from the date the property was placed in service, it ceases to be used as a QPP, then a portion of the previously deducted depreciation may be subject to recapture and taxed as ordinary income.

IRC Sec. 1245: Under the bill, QPP is treated as IRC Sec. 1245 property; meaning that upon disposition or sale, the gain will be taxed as ordinary income, up to the original purchase price of the property. (Gain in excess of the original purchase price will be taxed as capital gains.) Pass-through entities, however, still qualify for a deduction of up to 20% of qualified business income provided they are not a specified service trade or business. Additionally, this also means that QPP is not eligible for an exchange under IRC Sec. 1031.

State Conformity: Not all states conform to the IRC on a permanent basis, and many states that do conform to most of the code do not conform to bonus depreciation rules under IRC Sec. 168(k). The same may end up being true of IRC Sec. 168(n). Taxpayers may want to consider alternatives such as IRC. Sec. 179 if their state does not conform.

IRC Sec. 163(j): The OBBBA also revived the use of earnings before interest, taxes, depreciation, and amortization (EBITDA) as the starting point for calculating the business interest expense deduction limitation. The depreciation amounts under IRC Sec. 168(n) should count as depreciation for purposes of EBITDA and the 163(j) calculation.

Net Operating Losses: Some taxpayers may generate a net operating loss (NOL) by making an election to treat property as a QPP, which can be carried forward to future years. The NOL deduction allowed in future years is limited to 80% of taxable income, however, the NOL can be carried forward indefinitely to offset taxable income.

Planning Opportunities

The OBBBA presents an exciting opportunity for manufacturers and distributors to optimize their tax strategies and accelerate investment. To fully capitalize on these changes, especially the QPP deduction, businesses should:

• Reassess all planned capital expenditures plans, including new facilities and equipment, to align with the new bonus depreciation and QPP eligibility criteria.
• For new construction projects, a comprehensive cost segregation study will be essential to accurately delineate qualifying QPP costs from non-qualifying elements, thereby maximizing the available deduction.

If you have questions about how you can take advantage of IRC Sec. 168(n), contact our team to start the conversation.