This article was written by Ashley Sullivan, CCSP, Partner MSC, President, American Society of Cost Segregation Professionals.
The OBBBA expanded the depreciation landscape by introducing Qualified Production Property (QPP), a new provision aimed at incentivizing domestic production but layered with technical considerations taxpayers must now navigate. The IRS has released Notice 2026‑16, providing long‑awaited interim guidance on the new special depreciation allowance for Qualified Production Property (QPP) enacted under IRC §168(n). The Notice establishes an initial framework taxpayers may rely on as Treasury and the IRS work toward proposed and final regulations, addressing key concepts such as what constitutes a qualified production activity and qualified production property, how eligible basis is determined and allocated, and how and when the election to designate property as QPP is made. It also outlines special rules for lessor and leased property, dual‑use facilities, and depreciation recapture if property later ceases to qualify. Importantly, this guidance represents an early step in what is a new and evolving area of the tax code, and taxpayers should expect continued refinement as proposed and final regulations are issued—potentially modifying interpretations, mechanics, and compliance expectations as the government gains experience administering this significant new incentive.
Evaluating the Strategic Tradeoffs of QPP Elections
While the ability to immediately deduct up to 100% of qualifying costs under the Qualified Production Property (QPP) rules is undeniably compelling, the true tax impact extends well beyond the year of placement in service. The “what‑if” scenarios embedded in the guidance introduce meaningful downstream considerations that could result in significant tax consequences if not carefully evaluated upfront. States generally decouple from federal depreciation provisions, potentially creating unfavorable state‑level timing differences or permanent addbacks. Taxpayers must also weigh whether electing QPP treatment is optimal when compared to alternative strategies, such as leveraging Qualified Improvement Property or identifying 5‑, 7‑, and 15‑year land improvement assets through traditional cost recovery methods. These alternatives may offer accelerated deductions with more predictable outcomes and reduced exposure to future recapture. Under Notice 2026‑16, recapture risks arise if property ceases to satisfy the “integral part” requirement, is repurposed into another productive use that renders it disqualified property, or if there is a change in ownership structure, consolidated group status, or lessor or pass‑through entity use. Because each taxpayer’s facts and circumstances are unique, it is critical to evaluate QPP elections strategically—considering both short‑term cash tax benefits and long‑term implications—to determine the approach that best aligns with the taxpayer’s operational realities, risk tolerance, and overall tax posture.
Example: How a Change in Use Can Trigger Recapture
Notice 2026‑16 includes several detailed examples designed to demonstrate not only how the Qualified Production Property rules work mechanically, but also how easily favorable upfront results can unwind if facts or business operations change over time. For taxpayers, these examples serve as an important reminder that the 100% depreciation benefit comes with ongoing compliance requirements and potential recapture exposure that should not be overlooked. Walking through an example helps illustrate how a QPP election—while attractive at the outset—can give rise to significant and unexpected tax consequences in later years if the property ceases to meet the qualified use requirements. Understanding these scenarios is critical for taxpayers evaluating whether QPP is the right strategy for their specific facts and long‑term business plans.
Example Facts: Company B, a calendar‑year taxpayer, places a 72,000 square‑foot domestic manufacturing facility (Facility B) in service on January 1, 2028. The facility is used entirely as an integral part of a qualified production activity and has an unadjusted depreciable basis of $18,500,000. Company B elects under Notice 2026‑16 to treat the full basis of Facility B as Qualified Production Property (QPP). As a result, Company B claims a 100% special depreciation allowance of $18,500,000 for the 2028 taxable year, reducing its adjusted basis in the property to $0.
From January 1, 2028 through June 30, 2034, Facility B continues to be used as an integral part of a qualified production activity. Beginning July 1, 2034, however, Company B repurposes the facility for a different productive use that does not constitute a qualified production activity, causing the property to cease meeting the QPP requirements.
Example Analysis: Because Facility B is no longer used as an integral part of a qualified production activity, it undergoes a QPP change in use during the 2034 taxable year and becomes disqualified property. As a result, Company B is treated as having disposed of the property and must recognize ordinary income equal to the prior special depreciation allowance of $18,500,000 in 2034. The property’s adjusted basis is increased from $0 to $18,500,000 as of the beginning of the year of change in use.
For depreciation purposes going forward, the disqualified property is treated as a newly placed‑in‑service nonresidential real property asset as of January 1, 2034. Company B must depreciate the property using the straight‑line method over 39 years, applying the mid‑month convention. As a result, despite having already recognized $18.5 million of ordinary income recapture, Company B is limited to relatively modest annual depreciation deductions in subsequent years.
This example highlights the tension between the front‑loaded benefit of QPP and the back‑end exposure that may arise if facts or business operations change. By contrast, a strategy that allocates costs to Qualified Improvement Property (QIP) or 5‑, 7‑, and 15‑year assets, while often producing a smaller immediate deduction, generally avoids the risk of full ordinary‑income recapture tied to a change in qualified use. Accelerated recovery through QIP or land‑improvement allocations typically remains intact even if a facility’s operational purpose evolves, ownership structures change, or consolidation status shifts. As a result, taxpayers must carefully evaluate whether the certainty and durability of traditional accelerated depreciation outweigh the potential volatility associated with QPP elections, particularly where long‑term use, ownership, or business strategy is subject to change.
Technical Overview of Notice 2026 16
With those considerations in mind, we now turn to the substance of Notice 2026‑16 itself. Having framed the strategic questions taxpayers should be asking before pursuing a QPP election, the discussion that follows walks through the key sections of the Notice to explain how the rules are structured, what requirements must be satisfied, and where the IRS has drawn important boundaries. It is important to note that Section 4 introduces two specific exceptions that taxpayers can now consider when determining whether, as a lessor, they may claim Qualified Production Property (QPP) treatment. This overview provides the technical foundation necessary to evaluate whether the potential benefits of QPP align with a taxpayer’s specific facts, operational plans, and long‑term objectives.
Section 3 – General Definitions
Section 3 sets forth the defined terms used throughout the Notice. These definitions establish the foundational terminology necessary to understand the remaining provisions and provide consistency in how key concepts are applied. Because these terms are expressly defined for purposes of the Notice, they serve as the baseline for interpreting the qualification rules, elections, and recapture provisions addressed in subsequent sections.
Section 4 – Qualified Production Property
Section 4 addresses the requirements property must satisfy to qualify as Qualified Production Property. In general, QPP must be nonresidential real property that is MACRS property, placed in service in the United States or its territories, and used by the taxpayer as an integral part of a qualified production activity. The Notice explains the integral part requirement, including how it applies when only a portion of a property is used in a qualified production activity, and introduces a de minimis rule allowing an entire property to be treated as satisfying the requirement if 95 percent or more of its physical space qualifies at the time it is placed in service. Section 4 also provides rules for leased property, including exceptions for intercompany leases within consolidated groups and leases involving commonly controlled persons.
Section 4 of Notice 2026‑16 introduces a key area where taxpayers and practitioners had been waiting for guidance—how property is treated when the taxpayer is a lessor. Under this section, property leased to a lessee generally does not satisfy the integral part requirement; however, the Notice now provides two specific exceptions that taxpayers must consider when leasing property to a lessee. These exceptions address circumstances involving consolidated groups and commonly controlled pass‑through entities, and they establish how a lessor may determine whether the leased property meets the integral part requirement by reference to the lessee’s activities.
The Notice provides an exception for members of a consolidated group. If one member of a consolidated group owns and leases property to another member of the same group, the owner is not treated as a lessor for purposes of this rule. The consolidated group is treated as a single taxpayer, and whether the leased property satisfies the integral part requirement is determined by reference to the trade or business activities conducted by the lessee member in, or taking place within, the leased property.
A separate exception applies to commonly controlled pass‑through entities. When a partnership, S corporation, or individual leases property to a commonly controlled person, the lessor is not treated as a lessor for purposes of this rule. In these cases, whether the property satisfies the integral part requirement is determined by reference to the trade or business activities of the commonly controlled person conducted in, or taking place within, the leased property. The Notice defines a commonly controlled person by reference to 50‑percent or greater ownership, applying direct ownership or attribution rules, for a majority of the taxable year in which the property is placed in service, including the last day of that year.
Section 4 further explains how to determine the relevant unit of property, generally treating each building, including its structural components, as a single unit of property, while treating improvements or additions placed in service after the underlying asset as separate units. A special rule allows multiple properties operating as an integrated facility and located on the same or contiguous land to be treated as a single unit of property solely for purposes of satisfying the integral part requirement, while excluding property comprised solely of ineligible property from such treatment.
In addition, Section 4 addresses original use and construction timing requirements. The property must have construction begin after January 19, 2025, and before January 1, 2029, as determined under the beginning‑of‑construction rules in Section 4.05 of the Notice. In addition, the property must be placed in service after July 4, 2025, and before January 1, 2031, to satisfy the placed‑in‑service requirement. The Notice provides a special rule for certain used property not previously used in a qualified production activity, under which the original use and beginning of construction requirements may be treated as satisfied if specified conditions are met. Section 4 also identifies categories of ineligible property, including property used for offices, administrative services, lodging, parking, sales, research, software development, or other functions unrelated to a qualified production activity, as well as property used to store finished products.
Section 4 further provides rules for allocating unadjusted depreciable basis between eligible and ineligible property using any reasonable method that reflects the property’s facts and circumstances, and addresses the allocation of basis for dual‑use infrastructure. The section concludes by explaining how taxpayers designate the amount of eligible property treated as QPP, how QPP is treated as a separate class of property for purposes of electing out of other special depreciation allowances, and how limited relief is provided through an automatic extension of the placed‑in‑service deadline for property located in disaster areas.
Section 5 – Qualified Production Activity
Section 5 of Notice 2026‑16 addresses the definition of qualified production activities (QPA) and establishes the activity‑based framework used throughout the Notice to determine whether property may qualify as Qualified Production Property. Because the integral part requirement in Section 4 depends on whether a qualifying activity is conducted in, or takes place within, a property, Section 5 serves as the foundational link between how property is used and whether it may be eligible for the special depreciation allowance.
In general, Section 5 provides that a qualified production activity includes manufacturing, agricultural production, chemical production, or refining activities that result in the substantial transformation of tangible personal property into a qualified product. The Notice introduces and applies the substantial transformation concept by focusing on whether an activity results in a fundamental change in the nature or function of the tangible personal property, such that the output is a new, complete, and distinct product. These definitions are central to evaluating whether property is used as an integral part of a qualifying activity for purposes of Section 4.
Section 5 further distinguishes activities that are treated as qualified production activities from other activities that fall outside the scope of the definition. In doing so, the Notice identifies categories of activities that do not constitute qualified production activities for purposes of §168(n), even if those activities occur within the same facility. These distinctions are applied throughout the Notice in determining whether property, or a portion of property, satisfies the integral part requirement and whether property is treated as eligible or ineligible property.
In addition, Section 5 addresses how certain uses of property are treated in connection with a qualified production activity. The Notice differentiates between property used in connection with production processes and property used for other functions, including the storage of finished products and other non‑production activities. These rules are cross‑referenced in later sections of the Notice, including the allocation of basis rules in Section 4 and the depreciation recapture provisions in Section 8.
Taken together, Section 5 establishes the activity‑based criteria that underpin the Qualified Production Property framework. The definitions and distinctions set forth in this section are applied throughout the Notice, including in determining qualifying use under Section 4, allocation of basis between eligible and ineligible property, the scope of elections under Section 7, and whether a change in use has occurred for purposes of depreciation recapture under Section 8.
Section 6 – Special Rules
Section 6 of Notice 2026‑16 addresses a series of special rules that apply in conjunction with the general Qualified Production Property framework set forth in Sections 4 and 5. This section is intended to coordinate the application of the QPP requirements across specific ownership structures, transactional circumstances, and fact patterns that are not fully addressed by the baseline definitions and qualification rules.
Section 6 provides rules that clarify how Qualified Production Property is treated in circumstances involving property placed in service and disposed of in the same taxable year, property subject to basis redeterminations, and property acquired in certain non‑recognition transactions, including like‑kind exchanges and involuntary conversions. These provisions establish how QPP status is evaluated when property is acquired, transferred, or otherwise affected by events occurring close in time to the placed‑in‑service date.
The Notice also addresses how Qualified Production Property rules interact with other provisions of the Internal Revenue Code and existing depreciation regimes. Section 6 includes coordination rules that ensure the special depreciation allowance under §168(n) is applied consistently with related depreciation provisions, including rules governing basis, recovery periods, and prior depreciation treatment.
In addition, Section 6 provides clarifying rules that operate alongside the election mechanics described in Section 7 and the recapture provisions described in Section 8. These rules help define how QPP status is preserved or adjusted in special situations and ensure that the application of the Qualified Production Property provisions remains consistent throughout the life cycle of the property.
Section 7 – Time and Manner of Making Election
Section 7 of Notice 2026‑16 addresses the time and manner for making an election to designate property as Qualified Production Property under §168(n). This section is procedural in nature and serves as the mechanism through which the substantive rules set forth in Sections 4, 5, and 6 are applied. Without a valid election made in accordance with Section 7, property that otherwise satisfies the Qualified Production Property requirements does not receive the special depreciation allowance.
Section 7 provides that the election to designate property as Qualified Production Property is made by attaching an election statement to a timely filed federal income tax return for the taxable year in which the property is placed in service. The Notice specifies that the election is made on a property‑by‑property basis and requires the taxpayer to identify each property for which the election is made.
The Notice further addresses how the amount of Qualified Production Property is designated through the election. Section 7 requires the election statement to specify the dollar amount of the unadjusted depreciable basis of eligible property that the taxpayer intends to treat as Qualified Production Property. The Notice provides that a taxpayer may designate either the entire unadjusted depreciable basis of eligible property or a specific dollar amount that does not exceed such basis. An election statement that does not specify a dollar amount is treated as designating the entire unadjusted depreciable basis of the eligible property.
Section 7 also coordinates the Qualified Production Property election with other depreciation provisions under §168. The Notice provides that, for purposes of elections out of other special depreciation allowances, Qualified Production Property is treated as a separate class of property, and a taxpayer is treated as having made the applicable elections out of §§168(k), (l), and (m) with respect to any property designated as Qualified Production Property as part of making the §168(n) election. This coordination provision integrates the QPP election into the broader depreciation election framework.
In addition, Section 7 requires the inclusion of specific declarations within the election statement where applicable, including declarations related to the de minimis rule, disaster‑related placed‑in‑service extensions, and other provisions referenced elsewhere in the Notice. These requirements reinforce the role of the election statement as the central document through which the Qualified Production Property rules are implemented.
Section 8 – Depreciation Recapture
Section 8 addresses depreciation recapture when QPP undergoes a change in use. The Notice defines when a QPP change in use occurs within the 10‑year period beginning on the date the property is placed in service, including circumstances in which property ceases to satisfy the integral part requirement and becomes disqualified property. Special rules apply for leased property within consolidated groups and for leases involving commonly controlled persons, and the Notice clarifies that temporarily idle property does not result in a change in use.
When a QPP change in use occurs, the disqualified property is subject to §1245 recapture and is treated as disposed of at the time of the change. The Notice explains how to compute the recomputed basis of disqualified property, how gain is recognized and treated as ordinary income in the year of change, how basis is adjusted, and how depreciation is determined for the property after the change in use. Section 8 also provides rules for partial changes in use and clarifies that disqualified property is not eligible for certain depreciation elections in the year of change.
Key Takeaways
Taken together, Sections 3 through 8 of Notice 2026‑16 establish an interim framework governing the special depreciation allowance for Qualified Production Property under §168(n). Through a coordinated set of defined terms, qualification standards, activity‑based rules, election mechanics, and depreciation recapture provisions, the Notice provides a comprehensive structure for evaluating, designating, and monitoring Qualified Production Property throughout its lifecycle.
The Notice expressly permits taxpayers to rely on this guidance pending the issuance of proposed regulations and states that Treasury and the IRS intend those regulations to be consistent with the rules articulated in these sections. At the same time, the Notice signals that certain aspects of the regime may be refined through future guidance, underscoring both the interim nature of the framework and the importance of understanding how the provisions operate collectively rather than in isolation.
While Notice 2026‑16 offers a workable interim structure, several areas remain where additional guidance would promote consistent application and greater audit certainty. Practitioners continue to seek clearer boundaries around what constitutes “substantial transformation,” particularly for activities that fall between minor processing and full‑scale manufacturing. Similar uncertainty persists regarding the treatment of mixed‑use and integrated facilities that fail to satisfy the 95‑percent de minimis threshold, as well as the distinction between qualifying production‑related storage and non‑qualifying finished‑goods storage in complex facility layouts. Questions also remain concerning the practical application of the change‑in‑use and recapture rules over the ten‑year monitoring period—especially where facilities evolve incrementally or undergo partial repurposing—and how §1245 recapture interacts with common transactional events such as dispositions, restructurings, and like‑kind exchanges. Finally, although the Notice establishes clear election mechanics, additional administrative guidance addressing the correction or modification of elections in light of later basis adjustments or clarified rules would further enhance administrability as Treasury and the IRS move toward proposed regulations.
Notice 2026‑16 also requests that taxpayers and practitioners submit written comments to the IRS by April 20, 2026, signaling that Treasury is actively seeking feedback as it considers future guidance. As additional regulations are developed, the framework established in Notice 2026‑16 serves as the operative foundation for applying §168(n). Practitioners and taxpayers evaluating Qualified Production Property should therefore consider the definitions, requirements, elections, and recapture rules collectively, as set forth in Sections 3 through 8, while continuing to monitor further developments from Treasury and the IRS.
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