Qualified Production Property Expensing Under OBBBA: The CPA's Guide to IRC §168(n)

The One Big Beautiful Bill Act (OBBBA, enacted July 4, 2025) created IRC §168(n), a new 100% first-year expensing allowance for "qualified production property" — nonresidential real property used in domestic manufacturing, processing, refining, and related activities. This is materially different from the restored bonus depreciation under IRC §168(k), which applies to tangible personal property and qualified improvement property but does not cover newly constructed manufacturing buildings and structural components. For CPAs advising manufacturers, agricultural businesses, energy producers, and other industrial clients, §168(n) is the provision that allows a client constructing a $10 million domestic factory to deduct the entire cost in the first year of service rather than over 39 years at roughly $256,000 per year.

What Qualifies as Qualified Production Property

IRC §168(n) defines "qualified production property" as nonresidential real property (and its structural components) that meets all four of the following criteria:

1. Used in a qualified production activity. Qualifying activities include manufacturing, production, refining, extraction, mining, agriculture (including horticulture and aquaculture), and construction. The property must be actively used in the production activity — administrative buildings, sales offices, and warehouses that merely store finished goods generally do not qualify under the statutory definition. IRS Notice 2025-44 provides preliminary guidance on the activity-type boundary; the IRS has indicated it intends to issue proposed regulations.

2. Domestic location. The property must be located within the United States as defined in IRC §638 — the 50 states, the District of Columbia, and U.S. territorial waters. Puerto Rico and other U.S. territories do not qualify under §168(n) unless separately designated.

3. Original use begins with the taxpayer. The original use requirement mirrors the §168(k) rule: the taxpayer must be the first person to place the property in service. Acquisition of an existing manufacturing facility does not qualify. Gut rehabilitation of an existing building that amounts to new construction may qualify depending on the facts (see IRS Notice 2025-44 §4.04), but the analysis is fact-intensive.

4. Construction begins after January 19, 2025, and property is placed in service after that date. For buildings under construction at the OBBBA's enactment, the "construction begins" test follows the same safe harbor used for §168(k): the taxpayer has incurred at least 10% of total project cost. Any costs incurred before January 20, 2025 are not eligible.

The property that qualifies under §168(n) is almost entirely what would otherwise be 39-year nonresidential real property under MACRS — the class that bonus depreciation does not reach. This is the provision's primary significance: it extends 100% year-one expensing to the structural portion of a manufacturing build, the single largest component of most capital projects.

The Mechanics: How the §168(n) Deduction Works

The §168(n) deduction is 100% of the adjusted basis of qualified production property in the year placed in service. It is applied before depreciation under any other Code section and before the Section 179 election. Unlike Section 179, §168(n) has no income limitation — it can create or increase a net operating loss for the current year. Unlike §168(k) bonus depreciation, there is no phase-down schedule; the 100% rate is permanent under OBBBA.

The deduction appears on Form 4562 (Depreciation and Amortization). After the IRS releases Form 4562 instructions for 2025 and 2026 reflecting §168(n), the property will be identified separately from §168(k) bonus property. Until final forms are issued, practitioners should follow IRS Notice 2025-44 for reporting position guidance.

Electing out of §168(n): Taxpayers may elect out of the §168(n) deduction for any class of qualified production property placed in service during the year. The election is made on the return filed for the year the property is placed in service and is irrevocable without IRS consent. This is meaningful in several contexts discussed below — particularly where a client's income profile, state tax situation, or future sale plans make full expensing suboptimal.

How §168(n) Differs from Bonus Depreciation and Section 179

Three expensing provisions now apply simultaneously for manufacturing clients, and getting them confused creates planning errors. The table below distinguishes the key dimensions.

For a client building a new domestic facility, the practical sequencing is: §168(n) applies to the building and structural components; §168(k) applies to equipment and personal property installed inside; §179 may apply to certain personal property where the client prefers its specific income limitation behavior over bonus depreciation (e.g., selective deduction sizing). See How to Apply Bonus Depreciation and Section 179 for Business Clients in 2025 for the §179/§168(k) interaction analysis, which remains unchanged by the §168(n) addition.

Interactions That Require Planning

Depreciation Recapture at Sale

The single biggest planning concern for §168(n) property is recapture. When a taxpayer claims 100% first-year expensing under §168(n), the adjusted basis of the building drops to zero. If the property is later sold, the entire sales price (up to the amount expensed) is recaptured as ordinary income under IRC §1245 — not the 25% unrecaptured §1250 gain rate that applies to typical real property. This is because §168(n) property is treated as §1245 property for recapture purposes, regardless of its building classification for depreciation purposes.

The practical implication: a client who builds a $10 million qualifying production facility, expenses it under §168(n), and sells the facility five years later for $9 million recognizes $9 million of ordinary income — not capital gain. At a combined federal-state ordinary income rate of 40%+, that is a materially worse outcome than the 25% unrecaptured §1250 rate that would have applied under standard depreciation. Clients who anticipate selling the facility within the hold period should model the recapture cost against the time-value benefit of the front-loaded deduction. In some cases, electing out of §168(n) — or taking partial expensing and depreciating the remainder — produces a better after-tax outcome over the full hold period. For a detailed recapture framework, see Depreciation Recapture: How to Calculate and Explain It to Clients Selling Rental Property — the §1245 mechanics parallel the §1250 analysis and the §168(n) recapture follows the same computational structure.

Excess Business Loss Limitation

For pass-through entities (S corporations, partnerships, and sole proprietors), a large §168(n) deduction flowing to individual owners may exceed the excess business loss (EBL) threshold. For 2026, the EBL limit is $325,000 for single filers and $650,000 for married filing jointly (IRC §461(l); amounts indexed for inflation). Any business loss above that threshold is disallowed for the current year and converted into a net operating loss carryforward subject to the 80% limitation. A $10 million QPP deduction in a pass-through entity with two equal individual owners would generate a $5 million pro-rata share per owner — the EBL disallowance would apply to all but $650,000 for an MFJ filer, with the rest becoming a carryforward. See Excess Business Loss Limitation Under IRC §461(l) for the ordering rules and carryforward mechanics.

C corporations are not subject to §461(l). A manufacturing business operated as a C corporation can claim the full §168(n) deduction without the EBL cap — which may make C corporation status more attractive than pass-through treatment for large-scale domestic capital investment programs.

QBI Deduction: UBIA Wipeout

The Section 199A QBI deduction uses "unadjusted basis immediately after acquisition" (UBIA) of qualified property as one component of the W-2 wage limitation. For businesses near the phase-out range, the UBIA of property increases the deduction ceiling, making it possible to claim more QBI deduction than the 50%-of-wages prong alone would allow. When a building is fully expensed under §168(n), its UBIA for §199A purposes is the original cost — UBIA is not reduced by depreciation or expensing. This means QPP buildings continue to contribute to the §199A UBIA computation even after full expensing under §168(n), a significant benefit for capital-intensive manufacturing S corporations and partnerships. See QBI Wage-Limit Strategies Post-OBBBA for how UBIA interacts with the updated phase-out ranges.

State Tax Non-Conformity

As with bonus depreciation and §174A immediate R&D expensing, most states are unlikely to conform automatically to the federal §168(n) deduction. States with rolling conformity to the IRC (such as Delaware and Colorado) may adopt §168(n) by default; states with static conformity (such as New York, which conforms to a fixed IRC date) will not unless they separately enact conforming legislation. California, which largely decoupled from federal bonus depreciation, is expected to treat §168(n) property under its pre-OBBBA depreciation rules. The practical result: clients claiming large §168(n) deductions federally will likely need state depreciation adjustments, producing a significant addition modification on the state return in year one and offsetting subtraction modifications in subsequent years as state depreciation continues without a matching federal deduction. Model the state tax cost before finalizing the §168(n) election, particularly for multi-state manufacturers.

Comparison to Cost Segregation for New Construction

For clients building new manufacturing facilities, §168(n) raises a question about whether cost segregation studies still add value. The answer is: yes, but the analysis shifts.

Under pre-OBBBA rules, cost segregation was the mechanism for accelerating building depreciation — by reclassifying building components into 5-, 7-, and 15-year personal property, those components became eligible for bonus depreciation. Under OBBBA, the building itself (as QPP) can be expensed under §168(n), rendering cost segregation's reclassification function redundant for the structural component.

However, cost segregation retains value for:

• Qualified improvement property (QIP): Interior improvements to existing buildings, which are 15-year property eligible for §168(k) bonus depreciation regardless of §168(n).
• Partial §168(n) opt-out scenarios: If a client elects out of §168(n) for planning reasons, cost segregation restores accelerated depreciation on the reclassified components.
• State tax returns: If the state doesn't recognize §168(n), reclassifying building components into personal property may accelerate state depreciation through shorter state lives, producing state tax savings not available under §168(n).
• Acquisition of existing buildings: §168(n) requires original use — cost segregation remains the primary acceleration tool for acquired facilities.

See Cost Segregation Studies: How CPAs Accelerate Depreciation for Real Estate Clients for the QIP and lookback analysis, which applies to existing facility improvements even when §168(n) covers new construction.

When to Elect Out of §168(n)

The §168(n) elect-out is worth modeling when any of the following apply:

• High-likelihood near-term sale. Recapture converts the deduction benefit into ordinary income at sale. If the client expects to sell within 3–5 years, the time-value benefit of the front-loaded deduction may not outweigh the ordinary income rate differential versus §1250 capital gain treatment.
• Client has NOL carryforwards. If the client already has NOLs that exceed expected future income, adding more NOL carryforwards via §168(n) delays deduction utilization rather than accelerating it. Depreciation over 39 years may produce more usable deductions in the medium term.
• State tax efficiency is the priority. A state that doesn't conform to §168(n) produces the worst of both worlds: an addition modification in year one (increasing state tax) with subtraction modifications in later years (reducing state tax) — a permanent timing difference from the state's perspective. In some state tax environments, conventional depreciation produces lower total state tax cost.
• QBI phase-out income management. For clients near the §199A income phase-out threshold, a large §168(n) deduction reduces QBI income and may cause a service business (SSTB) client to fall into the phase-in range in a suboptimal way. Model the §199A interaction before claiming the full deduction.

FAQ

Does §168(n) apply to buildings used for warehousing finished goods?

Generally, no. IRC §168(n) requires the property to be used in a "qualified production activity." Warehouses that store finished manufactured goods without any production, processing, or transformation activity typically do not qualify. Distribution centers and logistics facilities face the same limitation. However, cold-storage facilities used in food processing or agricultural operations — where temperature control is integral to the production process — may qualify depending on the facts. Await proposed regulations for the definitive IRS position on mixed-use and adjacent-use facilities.

Can a manufacturer expense part of the building and depreciate the rest?

Yes. The §168(n) election is made by property class, not at the project level. For a project that includes both qualifying production space and non-qualifying administrative space (a common scenario in mixed-use industrial buildings), the taxpayer can apportion the basis between qualifying and non-qualifying portions — only the qualifying portion is eligible for §168(n) expensing. Alternatively, the taxpayer can elect out of §168(n) entirely and use cost segregation plus §168(k) bonus depreciation on the reclassified personal property components.

How does §168(n) interact with the Section 174A R&D expensing election?

For manufacturing clients that also conduct qualified R&E activities, the two provisions are independent. §174A (immediate R&E expensing) applies to research and experimental expenditures incurred in connection with the taxpayer's business, while §168(n) applies to the physical property used in production. A client building a manufacturing facility that also houses an R&D lab would apply §168(n) to the facility's structural and production costs, and §174A to the qualified research expenditures separately. See Section 174A R&D Expensing for the §174A small business retroactive election rules, which have their own timing deadlines.

Does §168(n) apply to sole proprietors and S corporation shareholders?

Yes — but the EBL limitation applies at the individual level, and the deduction may be partially disallowed in the current year and carried forward as an NOL. C corporations face no §461(l) limitation, which may make C corporation structure more attractive for clients undertaking large domestic capital projects where the full first-year deduction is critical to short-term cash flow planning.

What records do clients need to support a §168(n) deduction?

At minimum: (1) construction contracts and invoices showing amounts and dates, (2) evidence that construction began after January 19, 2025 (or invoices showing 10%+ of cost was incurred after that date for in-progress projects), (3) a use-characterization memo describing the qualified production activity conducted in the facility, and (4) evidence of domestic location. For mixed-use buildings, an allocation study supporting the qualifying-use percentage is essential. The IRS indicated in Notice 2025-44 that it may require additional disclosures on Form 4562 for §168(n) property; practitioners should monitor final form instructions before filing.

Arvori helps CPAs navigate OBBBA's expensing provisions — including §168(n), §174A, and restored bonus depreciation — by connecting them with manufacturing, agricultural, and industrial business clients who need accurate first-year cost analysis. If your practice serves capital-intensive businesses, reach out to see how Arvori can support client acquisition and cross-service delivery.