IRS Provides Interim Guidance on Bonus Depreciation for Qualified Production Property

(Parker Tax Publishing February 2026)

The IRS issued a notice providing interim guidance on the special depreciation allowance for qualified production property under Code Sec. 168(n), as added by the One Big Beautiful Bill Act (Pub. L. 119-21), and announcing that it will issue proposed regulations expected to be consistent with the interim guidance. The notice provides interim guidance regarding: (1) definitions of qualified production property and qualified production activity, (2) how to determine the special depreciation allowance for qualified production property, (3) how and when an election to treat property as qualified production property is made, and (4) how the depreciation recapture rules apply to property that ceases to meet the requirements to be qualified production property. Notice 2026-16.

Background

The One Big Beautiful Bill Act (OBBBA) added Code Sec. 168(n) to provide a temporary special depreciation allowance for qualified production property placed in service after July 4, 2025. Code Sec. 168(n)(1)(A) provides that, for any qualified production property for which an election is made, the depreciation deduction provided by Code Sec. 167(a) for the tax year such property is placed in service includes an allowance equal to 100 percent of the adjusted basis of the qualified production property. Code Sec. 168(n)(1)(B) provides that the adjusted basis of the qualified production property is reduced by the amount of the deduction under Code Sec. 168(n)(1)(A) before computing the amount otherwise allowable as a depreciation deduction for such tax year and any subsequent tax year.

Under Code Sec. 168(n)(2)(A), "qualified production property" (QPP) means the portion of any nonresidential real property:

(1) to which Code Sec. 168 applies,

(2) that is used by the taxpayer as an integral part of a "qualified production activity" (QPA) (as defined in Code Sec. 168(n)(2)(D)),

(3) that is placed in service in the United States or any territory of the United States,

(4) the original use of which commences with the taxpayer,

(5) the construction of which begins after January 19, 2025, and before January 1, 2029,

(6) that is designated by the taxpayer in an election under Code Sec. 168(n), and

(7) that is placed in service after July 4, 2025, and before January 1, 2031.

Code Sec. 168(n)(2)(B) provides special rules for determining whether certain used property may be qualified production property. Under Code Sec. 168(n)(2)(B)(i), a taxpayer that acquires used property after January 19, 2025, and before January 1, 2029, is treated as the original user of the property and the construction of the property is treated as having begun after January 19, 2025, and before January 1, 2029, if: (i) the property was not used in a qualified production activity (determined without regard to whether such activity resulted in a substantial transformation of the property comprising the qualified product) by any person at any time during the period beginning on January 1, 2021, and ending on May 12, 2025, (ii) the property was not used by the taxpayer at any time prior to such acquisition, and (iii) the acquisition of the property meets the requirements of Code Sec. 179(d)(2) and (3) (that is, the property is not acquired from a related party or by a member of a controlled group from another member of the same group, and the taxpayer's basis in the property is not determined by reference to its basis in the hands of the transferor).

The term "qualified production activity" is defined in Code Sec. 168(n)(2)(D) as the manufacturing, production, or refining of a qualified product that results in a substantial transformation of the property comprising the qualified product. Under 168(n)(2)(E), production does not include activities other than agricultural and chemical production.

Under 168(n)(6)(A), an election under Code Sec. 168(n)(6) for any tax year (1) must specify the nonresidential real property subject to the election and the portion of such property designated as qualified production property under Code Sec. 168(n)(2)(A)(vi), and (2) is generally made on the taxpayer's federal income tax return for the tax year. Further, such election is made in such manner as the IRS may prescribe by regulations or other guidance.

Notice 2026-16

On February 20, the IRS issued Notice 2026-16 to provide interim guidance on the qualified production property deduction and to announce that it intends to issue proposed regulations that are expected to be consistent with the interim guidance.

Qualified Production Property

For purposes of the definition of qualified production property in Code Sec. 168(n)(2)(A), the interim guidance in Section 4 of Notice 2026-16 provides that property, or a portion thereof, is used an "integral part" of a QPA and satisfies the integral part requirement if a QPA is conducted in, or takes place within, the physical space of such property or within a portion of the physical space thereof. If a QPA is conducted in, or takes place within, only a portion of the physical space of a property, only such portion satisfies the integral part requirement. Each unit of property must satisfy the integral part requirement on its own. Under a de minimis rule provided in Section 4.02(2), if 95 percent or more of the physical space of a property satisfies the integral part requirement at the time the property is placed in service, the taxpayer may elect to treat the entire property as satisfying the integral part requirement.

Section 4.06 of Notice 2026-16 provides a special rule for certain property not previously used in a QPA. In the case of used property acquired by a taxpayer after January 19, 2025, and before January 1, 2029, the original use requirement and beginning of construction requirement are treated as met if the following requirements are satisfied: (1) such property was not used in a QPA by any person at any time during the period beginning on January 1, 2021, and ending on May 12, 2025; (2) such property was not used by the taxpayer at any time prior to such acquisition; (3) the acquisition of such property meets the requirements of Code Sec. 179(d)(2)(A), (B), and (C), and Reg. Sec. 1.179-4(c)(1)(ii), (iii), and (iv); or Reg. Sec. 1.179-4(c)(2) (property is acquired by purchase); and (4) the acquisition of such property meets the requirements of Code Sec. 179(d)(3) and Reg. Sec. 1.179-4(d) (cost of property).

Ineligible Property

Consistent with Code Sec. 168(n)(2)(C) and (4)(B), Section 4.07 of Notice 2026-16 provides that ineligible property includes any portion of property used for offices, administrative services, lodging, parking, sales activities, research activities, software development or engineering activities, or other functions unrelated to a QPA. Additionally, any portion of property used to store finished products and certain other items is not used as an integral part of a QPA and is thus ineligible property. Ineligible property also includes any property, or a portion thereof, that contains a manufacturing, production, or refining activity, or any other activity, that is not within the scope of the definition of QPA provided in Section 5.01 of Notice 2026-16 (see below).

A taxpayer may use any reasonable method to allocate a property's unadjusted depreciable basis between eligible property and ineligible property. For this purpose, the use of square footage, cost segregation data, architectural or engineering plans, process diagrams, or construction invoices to allocate unadjusted depreciable basis to eligible property may be a reasonable method. In the case of property or a portion thereof which contains infrastructure that serves both eligible property and ineligible property (such as a central air conditioning system or a sprinkler system), a taxpayer may allocate the basis of such property between eligible property and ineligible property using any reasonable method.

Automatic Extension of Placed-In-Service Date Requirement

Under Section 4.11, an automatic one-year extension of the placed-in-service-date requirement is granted for any property that is located in a disaster area (as defined in Code Sec. 165(i)(5)(B)) at any time during 2030 (affected property). Accordingly, for affected property, the requirement to place property in service before January 1, 2031, is automatically extended to January 1, 2032. If a taxpayer applies this automatic extension of the placed-in-service-date requirement, the taxpayer must include a declaration to that effect on the election statement required under Section 7 of Notice 2026-16.

Qualified Production Activity

Under Section 5.01 of Notice 2026-16, the term qualified production activity (QPA) means the manufacturing, production, or refining of a qualified product. A trade or business activity of a taxpayer does not constitute manufacturing, production, or refining of a qualified product unless the trade or business activity of such taxpayer results in a substantial transformation of the property comprising the qualified product.

The term "substantial transformation of the property comprising a qualified product" means the further manufacturing, production, or refining of the constituent elements, raw materials, inputs, or subcomponents into a final, complete, and distinct item of property in the hands of the taxpayer that is fundamentally different from the original constituent elements, materials, inputs, or subcomponents. Examples of substantial transformation of the property comprising a qualified product include the conversion of wood pulp to paper, steel rods to screws and bolts, and freshly caught tuna fish to canned tuna. An example of an activity that does not result in a substantial transformation of the property comprising a qualified product is the grouping and packaging of multiple finished goods for sale as a single item, such as gift baskets, subscription boxes, and bundled electronics.

Safe Harbor for Property Placed in Service in 2025

For property placed in service after July 4, 2025, and on or before December 31, 2025, Section 5.03 of Notice 2026-16 provides that the taxpayer's trade or business activity conducted in, or taking place within, the property will be treated as a QPA if:

(1) The principal business activity code that the taxpayer, or the relevant trade or business of the taxpayer, used on its most recently filed federal income tax return (for example, 2024 Form 1040, Schedule C, line B; 2024 Form 1065, Item A; 2024 Form 851, Part II, or 2024 Form 1120, Schedule K, line 2a), filed before February 19, 2026, is an applicable NAICS code listed in Section 5.03(2) of Notice 2026-16; and

(2) Such activity results in, or is otherwise essential to the substantial transformation of the property comprising a qualified product.

An applicable NAICS code means any of the NAICS codes listed under sectors 31, 32, or 33, or under subsectors 111 or 112, that appear in the North American Industry Classification System (NAICS), United States, 2022, published by the Office of Management and Budget (OMB).

For a taxpayer that does not have such a filed federal income tax return because it is filing its first federal income tax return on or after February 19, 2026, the taxpayer must reasonably determine that its principal business activity code is an applicable NAICS code on its first federal income tax return to be eligible for this safe harbor.

Time and Manner of Electing to Designate Property as Qualified Production Property

A taxpayer designates and elects to treat property as QPP by making the election under Section 7 of Notice 2026-16 by the due date, including extensions, of the taxpayer's original federal income tax return for the tax year in which the eligible property is placed in service by the taxpayer. A taxpayer makes a designation and an election by attaching a statement to its federal income tax return for the tax year in which the eligible property is placed in service. The statement, entitled "STATEMENT PURSUANT TO SECTION 7 OF NOTICE 2026-16", must include the following information:

(1) The name and taxpayer identification number of the taxpayer making the election;

(2) For each property placed in service in the tax year for which an election is being made: (i) the street address, city, state, zip code, and a description of the property; (ii) the total unadjusted depreciable basis of the property; (iii) if the eligible property is less than the entire property, the dollar amount of unadjusted depreciable basis allocable to the eligible property, and a description that identifies the eligible property; and (iv) the dollar amount of the unadjusted depreciable basis of eligible property the taxpayer is designating as QPP (or a statement that the taxpayer is designating the entire unadjusted depreciable basis of the eligible property as QPP);

(3) If the taxpayer is applying the de minimis rule described in Section 4.02(2) of Notice 2026-16 to an eligible property, a declaration that the taxpayer is applying the de minimis rule described in Section 4.02(2) of Notice 2026-16 and identification of each eligible property to which the de minimis rule is applied; and

(4) If the taxpayer is using the automatic one-year extension of the placed-in-service-date requirement in Section 4.11 of Notice 2026-16, (i) a declaration that (A) the taxpayer is using the automatic one-year extension of the placed-in-service-date requirement in Section 4.11 of Notice 2026-16; and (B) each property for which the taxpayer is using the automatic one-year extension was located in a disaster area for all or a portion of 2030; and (ii) identification of each eligible property listed under Section 7.02(2) of Notice 2026-26 for which the taxpayer is using the automatic one-year extension of the placed-in-service-date requirement in Section 4.11 of Notice 2026-16, and identification of the federally declared disaster (as defined in Code Sec. 165(i)(5)) that established the disaster area applicable to each eligible property.

Applicability Date and Reliance

The IRS anticipates that the forthcoming proposed regulations will provide that rules consistent with the interim guidance provided in Sections 3 through 8 of Notice 2026-16 apply to property the construction of which begins after January 19, 2025 (or, in the case of property described in Section 4.06 of Notice 2026-16, that is acquired after January 19, 2025), and which is placed in service in a tax year beginning on or after the date the final Code Sec. 168(n) regulations are published in the Federal Register.

For property the construction of which begins after January 19, 2025 (or, in the case of property described in Section 4.06 of Notice 2026-16 that is acquired after January 19, 2025), and is placed in service in a tax year beginning before the date the forthcoming proposed regulations are published in the Federal Register or other published guidance is issued, a taxpayer may rely on the guidance provided in Notice 2026-16 provided that the taxpayer follows the guidance in its entirety for all QPP placed in service in such tax years, beginning with the first tax year with respect to which the taxpayer relies on the guidance provided in Notice 2026-16.

For a discussion of the qualified production property deduction, see Parker Tax ¶94,400.

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