What Is Qualified Production Property Under Section 168(n)?

Qualified production property is new in the Code. Section 70307 of P.L. 119-21, signed July 4, 2025, added IRC 168(n), a 100% first-year allowance for factory buildings, which until then depreciated over 39 years with no bonus. The IRS issued interim rules in Notice 2026-16 and summarized them in Publication 946 (2025). This guide covers the seven requirements, the dates, what counts as production, the space that never qualifies, the election, an illustration and the 10-year recapture rule.

The seven requirements in IRC 168(n)(2)(A)

Two more limits sit in the statute. A lessor cannot count a lessee's production as its own use, so a developer that builds a plant and leases it out gets nothing under 168(n) (the flush language after 168(n)(2)(A)). And property that must use the alternative depreciation system is excluded by 168(n)(4)(B).

Qualified production activity: substantial transformation is the test

IRC 168(n)(2)(D) defines a qualified production activity as the manufacturing, production or refining of a qualified product, and adds that the taxpayer's activities do not count “unless the activities of such taxpayer result in a substantial transformation of the property comprising the product.” The definitions narrow it further:

• Production means only agricultural production and chemical production (168(n)(2)(E)).
• Qualified product means tangible personal property, except food or beverages prepared in the same building as a retail establishment where they are sold (168(n)(2)(F)). A restaurant kitchen does not qualify; a food plant can.
• Substantial transformation, per Notice 2026-16 section 5.02(9), means further manufacturing, production or refining of inputs into a final, complete and distinct item that is fundamentally different from those inputs. The notice's examples: wood pulp to paper, steel rods to screws and bolts, fresh tuna to canned tuna. Grouping finished goods into gift baskets, subscription boxes or bundled electronics does not qualify, and section 5.02(5) says packaging, repackaging, labeling and minor assembly never count as a material change on their own.

The notice also carries a safe harbor for 2025 only (section 5.03): property placed in service after July 4, 2025 and before 2026 is treated as used in a qualified production activity if the taxpayer's principal business activity code on its last return filed before February 19, 2026 was a NAICS manufacturing code (sectors 31 to 33) or an agriculture code (subsectors 111 or 112), and the activity results in or is essential to a substantial transformation.

Space that never qualifies

IRC 168(n)(2)(C) excludes the portion of the building “used for offices, administrative services, lodging, parking, sales activities, research activities, software development or engineering activities, or other functions unrelated to the manufacturing, production, or refining of tangible personal property.” Notice 2026-16 section 4.07 adds space used to store finished products. Receiving and storing raw materials inside the plant does count as essential to production under section 5.01(2)(b).

Because eligibility is measured by physical space, the notice requires a unit-of-property analysis and lets the taxpayer allocate basis between eligible and ineligible space by any reasonable method (section 4.08). One relief valve: if 95% or more of the space qualifies when the property is placed in service, the taxpayer may elect to treat the whole property as qualifying (section 4.02(2)).

Illustration: a $10 million plant with offices and a finished-goods warehouse

The machinery inside the plant is separate. It is 7-year or similar property and takes 100% bonus depreciation under IRC 168(k) on its own, as described in the bonus depreciation guide. A cost segregation study is the usual way to separate the building shell, the process equipment and the excluded office space, and Notice 2026-16 section 4.08 accepts any reasonable allocation method.

Used buildings: the special rule

A building bought rather than built can qualify under IRC 168(n)(2)(B) if it is acquired during the construction window (after January 19, 2025 and before January 1, 2029) and three conditions hold: no person used it in a qualified production activity at any time from January 1, 2021 through May 12, 2025; the buyer never used it before; and the purchase meets the unrelated-party and cost rules of section 179(d)(2) and (3). A written binding contract fixes the acquisition date. The idea is to reward putting idle buildings into production, not to reward buying an existing factory.

How to elect, and why the election is hard to undo

Section 7 of Notice 2026-16 sets the procedure. The taxpayer attaches a statement titled “STATEMENT PURSUANT TO SECTION 7 OF NOTICE 2026-16” to its return for the year the property is placed in service, filed by the due date including extensions. The statement gives the taxpayer's name and identification number and, for each property, the address and description, the total unadjusted depreciable basis, the basis allocable to eligible space, and the dollar amount being designated as qualified production property. Publication 946 says the same. Each owner elects separately; for a consolidated group the agent for the group files it.

The election, once made, “may not be revoked except with the consent of the Secretary (and the Secretary shall provide such consent only in extraordinary circumstances)” (IRC 168(n)(6)(B)). The notice adds that revocation requires a private letter ruling and that a request which would let the taxpayer use hindsight does not meet the standard. Two side effects follow automatically: the designated property is treated as its own class that has elected out of bonus depreciation (168(n)(4)(A)), and it becomes section 1245 property under IRC 1245(a)(3)(G).

Recapture if the use changes within 10 years

IRC 168(n)(5) applies if, at any time in the 10 years after the property is placed in service, it stops being used as an integral part of a qualified production activity and the taxpayer uses it in some other productive use. The property is then treated as disposed of under section 1245 at that moment, with the amount realized deemed at least equal to the recomputed basis, so the depreciation taken comes back as ordinary income. Notice 2026-16 section 8 adds that the recognized gain is added to basis and the property is depreciated from the year of change as a new asset. Converting the plant to a distribution center in year six therefore reverses most of the year-one deduction. The notice also confirms (section 9) that taxpayers may rely on its sections 3 through 8 until regulations are published, provided they follow them in full for all qualified production property.

Sources: 26 U.S.C. 168(n), special allowance for qualified production property; 26 U.S.C. 1245(a)(3)(G), qualified production property as section 1245 property; Public Law 119-21, section 70307 (govinfo); IRS Notice 2026-16, interim guidance on qualified production property; IRS Publication 946 (2025), Qualified Production Property. Rules and dates checked against these sources on September 26, 2026. This is general information, not tax advice for your situation. Tax services are provided by licensed tax professionals under a separate engagement agreement. BEG does not provide tax advice.