The Department of the Treasury and the Internal Revenue Service (IRS) recently issued Notice 2026-16 to provide crucial administrative guidance regarding the new temporary special depreciation allowance. The primary reason the IRS has issued this notice is to announce that the Treasury Department and the IRS "intend to issue proposed regulations (forthcoming proposed regulations) addressing the special depreciation allowance for qualified production property under § 168(n) of the Internal Revenue Code (Code)".

Because the enactment of the One, Big, Beautiful Bill Act (OBBBA) significantly altered depreciation timelines for certain property, tax professionals require immediate operational rules. Notice 2026-16 bridges the gap between the statutory enactment and the eventual publication of final Treasury Regulations by offering interim guidance upon which taxpayers may rely.

Statutory Provisions Added by the One Big Beautiful Bill Act

Section 70307 of Public Law 119-21, commonly known as the OBBBA, fundamentally modified the Modified Accelerated Cost Recovery System (MACRS) by adding subsection (n) to I.R.C. § 168. This new provision establishes a temporary, 100-percent special depreciation allowance for qualified production property (QPP).

Specifically, I.R.C. § 168(n)(1)(A) mandates that "for any qualified production property for which an election is made, the depreciation deduction provided by § 167(a) for the taxable year such property is placed in service includes an allowance equal to 100 percent of the adjusted basis of the qualified production property". Furthermore, I.R.C. § 168(n)(1)(B) dictates that the adjusted basis of the QPP must be "reduced by the amount of the deduction under § 168(n)(1)(A) before computing the amount otherwise allowable as a depreciation deduction for such taxable year and any subsequent taxable year".

Interim Guidance Under Notice 2026-16

Pending the formal promulgation of proposed and final regulations, Notice 2026-16, Sections 3 through 8, sets forth detailed interim rules governing definitions, property eligibility, leasing arrangements, election mechanics, and recapture triggers.

Defining Qualified Production Property

Under I.R.C. § 168(n)(2)(A), QPP is strictly defined as the portion of any nonresidential real property that meets several rigorous statutory tests. Notice 2026-16 clarifies that to qualify as QPP, the property must be MACRS property that is "used by the taxpayer, or will be used by the taxpayer once placed in service, as an integral part of a qualified production activity".

The timeline for QPP is strict: the construction of the property must begin after January 19, 2025, and before January 1, 2029. Additionally, the property must be placed in service "after July 4, 2025, and before January 1, 2031".

The Notice also identifies specific exclusions. I.R.C. § 168(n)(2)(C) explicitly dictates that QPP "does not include any portion of nonresidential real property that is 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". Practitioners must ensure that their clients allocate the unadjusted depreciable basis between eligible and ineligible property using a "reasonable method," such as square footage or cost segregation data.

Alternatively, the IRS offers a taxpayer-friendly "de minimis rule," which dictates that 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".

Defining Qualified Production Activity

The core of the QPP allowance hinges on the property’s use in a Qualified Production Activity (QPA). I.R.C. § 168(n)(2)(D) defines QPA as "the manufacturing, production, or refining of a qualified product that results in a substantial transformation of the property comprising the qualified product". Notice 2026-16 formally defines this "substantial transformation" as the processing of raw materials 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".

The Notice specifies that certain related activities, while not themselves causing a substantial transformation, will not disqualify the property if they are "essential to the completion of the QPA". For example, the receiving and storage of raw materials "are activities essential to the QPA if they are conducted in, or take place within, the same property, or within the same integrated facility... as the QPA". Conversely, "any other storage activity not described in section 5.01(2)(b)(i) of this notice, such as the storage of finished products, is not an activity essential to a QPA" and thus constitutes ineligible property.

Election Procedures

To claim the allowance, taxpayers must affirmatively elect into the regime. Under I.R.C. § 168(n)(6)(A), the election must "specify the nonresidential real property subject to the election and the portion of such property designated as qualified production property". Notice 2026-16, Section 7.02 requires that this election be made by attaching a statement entitled “STATEMENT PURSUANT TO SECTION 7 OF NOTICE 2026-16” to the timely filed original Federal income tax return for the taxable year the property is placed in service. Once made, this election "may not be revoked except with the consent of the Secretary (and the Secretary may provide such consent only in extraordinary circumstances)".

Recapture Under Section 1245

Tax professionals must heavily caution clients regarding the recapture provisions. I.R.C. § 168(n)(5)(A) implements a 10-year look-forward period for changes in use. Notice 2026-16 states that a QPP change in use occurs if, within the 10-calendar-year period beginning on the date the property is placed in service, the property "ceases to satisfy the integral part requirement, and (ii) is used by the taxpayer in another productive use that results in the property that was previously QPP constituting disqualified property".

If a change in use occurs, I.R.C. § 1245 applies by "treating the property as having been disposed of when first used in a productive use that is not a qualified production activity, and (2) treating as ordinary income the excess of the property’s recomputed basis, as defined in § 1245(a)(2), over its adjusted basis".

Expectations for Future Guidance

Notice 2026-16 serves as a structural bridge to future regulatory codification. The IRS explicitly states that the Treasury Department and the IRS expect the forthcoming proposed regulations to be "consistent with the interim guidance provided in sections 3 through 8 of this notice". Furthermore, the IRS anticipates that the forthcoming proposed regulations will formally apply to property for which construction begins after January 19, 2025, and is placed in service in a taxable year beginning on or after the date the "final § 168(n) regulations are published in the Federal Register".

Until those regulations are published in the Federal Register, tax professionals and their clients "may rely on the guidance provided in sections 3 through 8 of this notice, provided that the taxpayer follows the guidance provided in sections 3 through 8 of this notice in its entirety for all QPP placed in service in such taxable years".

Prepared with assistance from NotebookLM.