IRS issues notice on qualified production property depreciation

On Feb. 20, 2026, the Department of the Treasury and the IRS released interim guidance on a new 100% special depreciation allowance for qualified production property, or QPP, enacted under the One, Big, Beautiful Bill Act (OBBBA). Notice 2026-16 outlines how taxpayers may claim the deduction and what to expect from forthcoming proposed regulations. 

For tax professionals with manufacturing, agricultural, chemical or refining clients, this is not just another depreciation update. It is a temporary, potentially full-expensing opportunity for certain nonresidential real property used in qualifying production activities. 

Why the IRS released the notice

Congress added the new §168(n) to encourage domestic production investment. The statute provides a 100% depreciation allowance for certain production-related real property placed in service after July 4, 2025, and before Jan. 1, 2031.

But the statutory language left many practical questions unanswered. What qualifies as “substantial transformation”? How should basis be allocated between production space and non-qualifying space? What happens if the property later changes use?

Notice 2026-16 provides interim answers and signals that proposed regulations are on the way. Taxpayers may rely on the notice until regulations are issued, provided they follow it in its entirety.

What qualifies as qualified production property?

In general, QPP is the portion of any nonresidential real property that:

• Is MACRS property
• Is used as an integral part of a qualified production activity
• Is placed in service in the United States or a U.S. territory
• Has original use beginning with the taxpayer
• Begins construction after Jan. 19, 2025, and before Jan. 1, 2029
• Is placed in service after July 4, 2025, and before Jan. 1, 2031
• Is not subject to the alternative depreciation system

The property must also be designated as QPP in a timely election attached to the taxpayer’s return. This is not a blanket write-off for entire buildings. Office space, administrative areas, parking, lodging, sales areas and certain other functions are explicitly excluded. Taxpayers must allocate unadjusted depreciable basis between eligible and ineligible portions using a reasonable method, such as square footage or cost segregation data. 

What is a qualified production activity?

The activity must involve manufacturing, production or refining of a qualified product and result in a substantial transformation of tangible personal property. 

Manufacturing requires a material change in form or function that produces a new and distinct item. Packaging or minor assembly does not qualify. Refining includes processes such as petroleum distillation or purifying metals. Agricultural production covers cultivating crops and raising livestock.

The notice provides detailed examples, including a tomato sauce facility that qualifies for its core processing space but not for finished goods storage. These examples offer practical insight into how narrowly or broadly the IRS may interpret “integral part” and “substantial transformation.”

Election and compliance details

The election to designate property as QPP must be made on a timely filed original tax return, including extensions, for the year the property is placed in service. A statement titled “STATEMENT PURSUANT TO SECTION 7 OF NOTICE 2026-16” must be attached and include detailed property information along with the amount designated as QPP. 

An election revocation requires IRS consent and will be granted only in extraordinary circumstances. This is not an election to make lightly. Tax professionals should also note the coordination rules governing how §168(n) interacts with bonus depreciation under §168(k), ADS and recapture provisions. QPP is treated as a separate class of property. If a taxpayer elects QPP treatment under §168(n), the 100% allowance is claimed under that provision rather than under §168(k) bonus depreciation for that property.

Recapture risk: the 10-year lookback

There is a significant recapture provision. If, within 10 years, the property ceases to be used as an integral part of a qualified production activity and is used for another productive use, the special recapture rule applies and the prior §168(n) deduction is treated as §1245 ordinary income. In plain terms, that 100% deduction can come back as ordinary income if the building is repurposed. The notice includes examples of full or partial recapture and of how depreciation resumes after a change in use. 

Comments requested

Treasury and the IRS are seeking comments on basis allocation methods, definitions of manufacturing and refining, and additional examples of substantial transformation. Comments are due within 60 days of issuance; see pages 48-49 of the notice for more details. The 100% allowance is powerful, but it is technical and temporary. As always, the opportunity lies in understanding the details and applying them carefully.