Summary: The IRS recently issued Notice 2026-16, providing much-anticipated clarity on the new 100% bonus depreciation deduction for Qualified Production Property (QPP) under Section 168(n). The guidance addresses several key areas that had created uncertainty for taxpayers, including what constitutes a qualified production activity, treatment of self-rentals, how to apply the “substantial transformation” standard, and how to treat mixed-use and integrated facilities.

A new era of full expensing for production-focused real estate has arrived, but it brings with it some complexity. Section 168(n) was enacted as part of 2025’s One Big Beautiful Bill (OBBB), and it opened the door to significant tax savings for manufacturers and producers. However, many practical questions remained unanswered at the time. Now, with the release of IRS Notice 2026-16, taxpayers have clearer direction on how to turn this opportunity into action.

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The One Big Beautiful Bill (OBBB) created many new tax savings opportunities for manufacturers, but maybe none more desirable than IRC Section 168(n), which allows taxpayers to take 100% bonus depreciation on Qualified Production Property (QPP). This means manufacturers, refiners, and producers can fully expense eligible real property. While the inclusion of the provision was exciting, it left many questions unanswered. In recent weeks, however, the IRS released IRS Notice 2026-16, which provides taxpayers with interim guidance.

The notice addresses several key issues:

• What constitutes a qualified production activity, and what substantial transformation means
• How to treat mixed-use facilities
• A self-rental exception for leased property
• Basis allocation

What Is QPP?

Taxpayers may elect to deduct 100% of the adjusted basis of certain nonresidential real property used in qualified production activities that meet the QPP requirements:

• The property is nonresidential real property that is used as an integral part of a qualified production activity (QPA)
• Construction begins after Jan. 19, 2025, and before Jan. 1, 2029
• Placed in service after July 4, 2025, and before Jan. 1, 2031, in the U.S. or possessions
• Original use requirement (with special rules for certain used property not previously used in manufacturing)

Key Clarifications in IRS Notice 2026-16 for QPP Bonus Depreciation 

IRS Notice 2026-16 provides important clarity on several technical aspects of the QPP deduction, including how to define qualified production activities, apply the substantial transformation standard, and treat mixed-use and leased properties. It also outlines practical approaches for determining construction start dates and allocating basis between qualifying and non-qualifying areas. Together, these updates help taxpayers better evaluate eligibility and apply the new rules with greater confidence.

Leased Property

One significant area of uncertainty was whether there would be a special carve out for self-rental properties (i.e., when the real property is broken out from the operating entity into a separate legal entity for both legal and tax reasons). The IRS clarifies that where certain ownership thresholds and/or filing requirements are met, that the lessor of the property is eligible for the QPP deduction. This is a significant win for taxpayers.

Construction Start Date

The notice incorporates the 10% safe harbor from existing bonus depreciation regulations to identify the start date of the construction. The 10% safe harbor allows taxpayers to use the date at which 10% of the project’s construction costs, excluding certain soft costs, were incurred. This potentially allows construction projects that started before Jan. 20, 2025, but were in the early stages of construction, to qualify for QPP.

Qualified Production Activity (QPA) Defined

The IRS clarified what constitutes “substantial transformation” focusing on to the extent there is further manufacturing, production, or refining and whether a complete, distinct item of property is created. The IRS also states, “In no event will a change in form or function resulting solely from packaging, repackaging, labeling, minor assembly operations, or a combination thereof, be considered a material change to the form or function of tangible personal property.” The notice also requests further comments from taxpayers and practitioners which will hopefully lead to further examples in future guidance.

“Integral Part” Requirement Clarified and Integrated Facility Rule

Only the portion of a building where the production activity physically occurs qualifies as QPP. However, if at least 95% of the building is used for qualified production, taxpayers may elect to treat the entire facility as qualifying. The notice clarifies that raw material storage can qualify as QPP, whereas finished goods storage and other storage does not qualify. The notice provides for an “integrated facilities” rule that allows taxpayers to treat multiple buildings as a single unit for purposes of the integral part test if they operate as an integrated facility and are located on the same or contiguous property. For example, this could allow a building dedicated solely to the storage of raw materials to qualify if it is part of an integrated facility with a qualified production activity.

Basis Allocation Between Eligible and Ineligible Areas

Many taxpayers will have qualifying and non-qualifying areas. The notice provides that taxpayers may use any reasonable method to allocate basis between qualifying and non-qualifying portions of property, including square footage and cost segregation data. The notice states that employee headcount or time spent is not considered reasonable.

Other Key Takeaways

The Notice confirms that QPP does not apply only to new construction projects. Upgrades to existing property (e.g., upgrade to the electrical system) can qualify as QPP. Even taxpayers who are not expanding their footprint should be considering their QPP. Additionally, the notice provides further guidance on the mechanics of the recapture rules which applies if the property ceases to be used in a qualified production activity within 10 years. If applicable, prior QPP deductions may be subject to IRC Section 1245 recapture as ordinary income. The notice also provides the required election statements for electing QPP treatment.

Maximize Your QPP Tax Savings

With new IRS guidance in place, manufacturers have a clearer path to fully expense qualifying production property. Now is the time to assess your eligibility and capture available tax savings. Connect with our team to make the most of this opportunity.

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State Tax Treatment of Section 168(n): Conformity, Decoupling, and QPP Bonus Depreciation Impacts

Beyond the federal implications, the state income tax landscape around Section 168(n) is also evolving. With many states in the midst of legislative sessions, a recurring issue is whether and how states conform to the OBBB’s provisions overall, and this includes Section168(n). State conformity ultimately determines whether the federal benefit of 100% bonus depreciation on QPP carries through to states for income tax purposes.

Rolling Conformity States

In rolling conformity states, Section 168(n) is generally followed unless the state has expressly decoupled from the provision, typically through a statutory modification. What this means for rolling conformity states is we can have different outcomes in different states. Some rolling conformity states, such as Colorado and New York, follow Section 168(n) by default since they conform to the current version of the IRC and have not, as of the date of this publication, enacted statutory modifications that expressly decouple from Section 168(n).

Other rolling conformity states have chosen to decouple from Section 168(n), creating timing differences for taxpayers. For example, Illinois enacted legislation decoupling from Section 168(n) for tax years beginning on or after Jan. 1, 2026. As a result, any Illinois benefit from the federal 100% bonus depreciation deduction on QPP appears limited to 2025, with an Illinois adjustment required for tax years beginning on or after Jan. 1, 2026.

Static Conformity States

In states with static conformity (i.e., fixed date), the result generally turns on the state’s IRC conformity date and whether that date includes Section 168(n)’s 100% bonus depreciation deduction on QPP. Even where a static conformity state adopts the IRC as of a date that includes Section 168(n), it may still decouple from said federal provision and require an addback to reverse the federal benefit, as seen with states such as Idaho.

Selective Conformity States

In selective conformity states, the state may choose not to utilize federal adjusted gross income or federal taxable income as the starting point for state income tax returns. As a result, the state may not need to address Section 168(n) directly since the 100% bonus depreciation deduction on QPP may not flow through automatically to affect the state’s income tax return.

Navigating State Conformity to Section 168(n): Key Risks and Planning Considerations

While any incremental state income tax cost will rarely outweigh the value of the federal benefit, taxpayers evaluating or utilizing the Section 168(n)’s QPP deduction should keep a close eye on state conformity and any legislation coming out of states’ legislative sessions. State treatment may not track federal results, particularly where a state’s means of conforming to the IRC – whether rolling, static, or selective – is paired with specific decoupling provisions, separate state depreciation methods, or timing adjustments that can unwind or defer Section 168(n)’s federal benefit.

Furthermore, most states do not automatically adopt IRS notices as part of their conformity provisions. For these reasons, IRS notices such as 2026-16 are persuasive or useful for state taxpayers and practitioners, but they are not binding unless the state tax code or regulations specifically incorporate it. A careful review of each state’s conformity statute and any modifications related to Section 168(n) is essential to avoiding surprise state treatment, timing mismatches, basis differences, or impacts to state attributes.

What’s next for Section 168(n)? Future IRS Guidance and Planning Considerations for QPP Bonus Depreciation

The IRS guidance in Notice 2026-16 is a helpful and meaningful step in the right direction for taxpayers. The Treasury is requesting comments and intends to issue future regulations on the topic. In the meantime, taxpayers can rely on the notice so long as they apply all parts of the notice. And while many provisions of the notice are helpful, it’s important to note that this guidance is not binding on taxpayers, and some taxpayers with very unique facts may choose to not follow the notice.

As with any new law, there are still questions to navigate and details to clarify. Whether you’re in the middle of an existing project or preparing to start a new one, reach out to your KSM advisor or contact us via the form below to understand the potential benefits and ensure your project is positioned to take full advantage of the available opportunities.

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