Qualified Production Property – What Do We Know?

The One Big Beautiful Bill Act (OBBBA) included many business-friendly provisions designed to spur investment. These included reductions in tax rates, a return to R&D expensing, and 100% bonus depreciation. Even with all of these exciting provisions, a new deduction for manufacturing properties may be generating some of the most excitement.

A deduction for “Qualified Production Property” (QPP) was added to the bill to stimulate US manufacturing growth. QPP was added to the code under 168(n) and allows for the immediate deduction of real estate used in qualified production. Unlike bonus depreciation, which is typically allowed only for short-lived assets such as personal property, this deduction provides expensing of the building itself. However, as with many issues, the devil is in the details. What qualifies, how the deduction is taken, and limitations on the deduction are still unclear.

The first step in determining whether a property is QPP-eligible is to understand the definition of Qualified Production. The OBBBA defines Qualified Production as “the manufacturing, production, or refining of a qualified product.” It goes on to state that the property does not qualify “unless the activities of such taxpayer result in a substantial transformation.” But what defines “substantial transformation”? The bill states that regulations will be issued consistent with the guidance under 954(d).

Under existing rules, certain activities qualify as substantial transformation, including converting wood pulp into paper, machining screws, and other manufacturing operations. However, to what extent will these examples be expanded upon? Will a screen printing operation be considered substantial? What about a facility doing assembly of parts manufactured elsewhere? This uncertainty could drastically affect the properties that ultimately qualify.

This also raises concerns about which parts of a facility qualify. The law states that there is an exclusion space 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.” While some of this is well defined, the statement “other functions unrelated” leaves many questions.

When looking at a manufacturing facility, can raw material storage, or finished good storage be included? If so, to what extent? For a taxpayer who builds a 100,000-square-foot manufacturing facility and stores raw materials in 30% of the building, does the entire space qualify, or do only the areas qualify where manufacturing is completed? These are questions that regulations will help answer.  

One of the biggest questions in the bill relates to leased space. Under this new provision, property to which the taxpayer is a lessor, used by a lessee, does not qualify. For most small businesses, real estate is held in a real estate holding company, while manufacturing is conducted in an operating entity. Does this qualify for the deduction, or does the real estate now have to be held in the operating entity? The IRS could choose to follow the lease rules under the Qualified Leasehold Improvement provision that were in place before the TCJA, or it could determine whether real estate and operating entities can be combined under 469.  Until the IRS provides guidelines, it is unclear if real estate holding companies will qualify.

These are just some of the questions that remain to be determined. Other questions, including how the election is conducted, whether it is all-or-none, how the recapture provision works, and others, will need to be sorted out. Companies planning to take this new deduction should be aware of the questions that remain. Understanding this in detail can help ensure companies do not miss out on this lucrative incentive. 

While navigating the complexities of the QPP deduction, bonus changes, or 174 changes, feel free to reach out to Dave McGuire or your relationship manager with any questions.