What Section 168(n) does
A commercial building normally depreciates over 39 years. The One Big Beautiful Bill Act, signed July 4, 2025, added Section 168(n) to the tax code, and it changes that for one kind of building. If the building is used as an integral part of manufacturing, production, or refining, the owner can elect to deduct 100 percent of the basis of the qualifying portion in the year the building is placed in service.
Read that again, because it is the opposite of how depreciation has always worked for real property. Bonus depreciation applies only to property with a recovery period of 20 years or less, which is why it reaches carpet, specialty electrical, and site paving but never the walls and roof. Section 168(n) is written for the walls and roof.
The law calls the qualifying building qualified production property, and the activity inside it a qualified production activity. The IRS issued interim guidance in Notice 2026-16 on February 20, 2026, and has said proposed regulations are coming. Until they arrive, a taxpayer who follows the notice in its entirety can rely on it.
The four things that have to be true
1. The building is used to make something
The statute requires manufacturing, production, or refining of a product that results in a substantial transformation of the materials. The notice describes manufacturing as materially changing the form or function of tangible property to create a new item held for sale, lease, or rent, and refining as purifying a substance into a more useful, higher-value product. The test is whether raw inputs come out the other end as something fundamentally different.
Storage, sales, and distribution do not count. The notice draws the line at finished goods: space where raw materials wait to go into the process is part of the activity, and space where finished products sit before shipping is not. One statutory exclusion is worth knowing if you run a food business: food or beverage prepared in the same building as the retail establishment that sells it does not qualify.
2. The dates line up
Construction of the building must begin after January 19, 2025 and before January 1, 2029. The building must be placed in service after July 4, 2025 and before January 1, 2031. Both windows have to be met. If you broke ground in 2024, the building does not qualify no matter when it opens.
An existing building can qualify too, under a separate rule. If you acquire a building in that same construction window, and no one used it in a qualified production activity at any time between January 1, 2021 and May 12, 2025, and you never used it yourself before buying it, the acquisition can satisfy the original-use requirement. A written binding contract fixes the acquisition date. That opens the door for a manufacturer buying a former warehouse or a long-idle plant.
3. You use it yourself
The building has to be used by the taxpayer as an integral part of the taxpayer's own production activity. A landlord whose tenant manufactures in the building generally does not qualify. The notice carves out two exceptions: companies filing a consolidated return are treated as one taxpayer, and a building owned by a partnership, S corporation, or individual and leased to a commonly controlled operating company can qualify when the same person or group owns 50 percent or more of both sides. That second exception matters, because a great many owner-operators hold the real estate in one entity and the business in another.
4. You elect it
Section 168(n) is not automatic. The taxpayer designates the property in a statement attached to a timely filed original return for the year the property is placed in service, and the notice spells out what that statement has to contain, including the dollar amount of basis being designated. Once made, the election can be revoked only through a private letter ruling and only in extraordinary circumstances. Get the number right the first time.
The part that requires an allocation study
Almost no manufacturing building is 100 percent production floor. The statute excludes any portion used for offices, administrative services, lodging, parking, sales activities, research activities, software development or engineering activities, or any other function unrelated to manufacturing, production, or refining. The basis of the building has to be divided between the qualifying portion and everything else, and only the qualifying portion gets the 168(n) allowance.
Notice 2026-16 allows any reasonable allocation method and names the evidence it expects: square footage, cost segregation data, architectural or engineering plans, process diagrams, and construction invoices. It names one method that is not reasonable: employee headcount or employee time. Shared infrastructure, such as a mechanical room or a loading dock that serves both the plant floor and the offices, has to be allocated the same way, based on actual or planned use.
That is an engineering exercise, and it is the same work a cost segregation study already does: walking the building, measuring it, pricing its components, and documenting where every dollar of basis sits. The allocation study I deliver through CSSI produces the square footage and cost data the election statement needs, and it holds up because it was built from the building rather than from a rule of thumb.
How this fits with cost segregation. The two rules cover different pieces of the same building. A cost segregation study identifies the 5, 7, and 15-year property that regular 100 percent bonus depreciation reaches. Section 168(n) reaches the structure itself, which bonus never touches. A manufacturer who does both can deduct most of a new facility in year one, everything except land and the excluded space. One site visit supports both.
The catch: ten years of recapture exposure
If, within ten years of placing the property in service, the building stops being used in a qualified production activity and you put it to some other productive use, the deduction comes back as ordinary income under section 1245 in the year of the change. Not capital gain. Ordinary income. The notice does treat a temporarily idle facility as still qualifying, so a slow quarter is not a change in use, but converting the plant floor to a showroom or leasing it to a tenant who does something else is.
Plan for that before you elect, not after. If there is a real chance the building's use changes inside ten years, the arithmetic of a 100 percent deduction now against ordinary income later deserves a hard look with your CPA.
What is still unsettled
This is interim guidance, and I want to be straight about what that means. Notice 2026-16 is what the IRS has said so far; proposed regulations are expected and could tighten or clarify the definitions, particularly around what counts as substantial transformation and how mixed-use space gets treated. States do not all follow federal depreciation rules, and several decouple from bonus depreciation already, so the state result may look nothing like the federal one. And the section 1245 recapture rule means the decision to elect is a judgment call, not a reflex. None of that is a reason to ignore the allowance. It is a reason to run the numbers with someone who reads the notice rather than the headline.
Questions owners actually ask
We are a job shop. Does machining count as manufacturing?
The test is substantial transformation: does raw material come out as a new, distinct item? Cutting, forming, and assembling stock into finished parts is squarely what the notice describes. Repackaging or light handling is not. Describe the process on the no-cost review and we will look at it together.
Our real estate is in an LLC and the operating company leases it. Are we out?
Not necessarily. The notice allows a building owned by a partnership, S corporation, or individual and leased to a commonly controlled operating company to qualify, when the same person or group owns at least 50 percent of both. The ownership has to be documented, and the rest of the requirements still apply.
Can I use square footage alone to allocate?
The notice lists square footage first among the reasonable methods. Whether it is enough depends on the building. When the production floor has far more cost per square foot than the offices, because of slab thickness, power, process piping, or clear height, a square-footage-only split understates what qualifies. That is where cost data from an engineering study earns its keep.
We placed the building in service in late 2025, before the notice came out. Can we still elect?
The notice says taxpayers may rely on it for property placed in service in a taxable year beginning before the proposed regulations are published, provided they follow the notice in full. The election is made on a timely filed original return for the placed-in-service year, including extensions. If that return has already been filed, talk to your CPA now about what procedural options exist. I am not going to guess at that on a web page.
Hear it explained
Find out whether your building qualifies
A no-cost review starts with two questions: when construction began, and what happens inside the building. From there it tells you whether the dates and the activity fit, roughly what portion of the basis qualifies, and whether the recapture exposure changes the answer. No obligation, no pitch, and if a study will not pay for itself, you will hear that from me first.