IRS Notice 2026-16: What Taxpayers Need to Know About Qualified Production Property

New guidance outlines how production facilities can qualify for bonus depreciation under strict use and timing requirements

IRS Notice 2026-16 (the Notice) establishes a new category of qualified production property (QPP) eligible for a special bonus depreciation regime when used in a qualified production activity (QPA) and meeting strict timing and use requirements.

Background and effective dates

Notice 2026-16 defines QPP and related concepts for purposes of a new bonus depreciation allowance available for certain nonresidential real property used in production activities. To qualify, construction of the property generally must begin after January 19, 2025, and before January 1, 2029, and the property’s original use must begin with the taxpayer in the United States or a U.S. possession.

For self‑constructed property, a safe harbor provides that if less than 10% of the total construction is completed before January 19, 2025, the property is treated as having begun construction after that date and can still qualify.

Definition of qualified production property and qualified production activity

Notice 2026-16 treats QPP as nonresidential real property used as an integral part of a QPA. A QPA generally consists of the manufacturing, production, or refining of a qualified product and must involve substantial transformation of the product’s components.

Substantial transformation requires that the property undergoes the process of experiencing a significant change in form, character, or use, such that it cannot readily be converted back into the original components. Activities such as stamping or molding of parts will often help satisfy this standard, whereas mere packaging, labeling, or minor assembly activities, or the storage of finished goods, do not constitute substantial transformation.

Integral part requirement, 95% de minimis test, and integrated facilities

QPP must be used as an integral part of the QPA, which focuses on whether the property is directly involved in, or essential to, the production process that achieves substantial transformation.

Notice 2026-16 adopts a 95% de minimis test that allows taxpayers to treat an entire property as satisfying the integral‑part requirement if at least 95% of the property’s physical space is used for QPA at the time it is placed in service, as reflected in an election made in the taxpayer’s election statement.

Ordinarily, each unit of property must independently satisfy the integral‑part requirement, but the Notice provides special rules for integrated facilities, under which multiple units on the same site that function together as a single production operation may be evaluated more broadly for purposes of the integral‑part standard.

In practice, this framework generally means that production floors, processing lines, and directly supporting utility and mechanical areas can qualify, while stand‑alone office areas or general administrative space that are not integral to the production process will typically fail the integral‑part test, even if located on the same site.

Property that does not qualify

Notice 2026-16 excludes certain property from QPP status even if located at an eligible facility. Most notably, any property required to be depreciated under the alternative depreciation system (ADS) of IRC § 168(g) is not QPP, and QPP itself is treated as a separate class of nonresidential real property for ADS purposes. Accordingly, taxpayers that have made the interest‑limitation election under IRC § 163(j) to use ADS for certain property may disqualify that property from QPP treatment.

More broadly, areas dedicated primarily to non‑production functions, such as general office space, administrative areas, and storage of finished goods, generally will not meet the integral‑part requirement and will be treated as non‑QPP even when located within the same overall facility.

The 10% construction safe harbor described above applies only to self‑constructed property; property that was substantially completed or in production before the applicable dates will not qualify as QPP.

Change in use and recapture

As with other bonus depreciation regimes, the Notice contemplates recapture if a property initially treated as QPP ceases to be used predominantly in a QPA. For example, converting a production area into general office space or repurposing a facility so that it no longer conducts substantial‑transformation production could trigger recapture of the previously claimed special depreciation allowance.

Self‑rental and consolidated group rules

Ordinarily, property leased by a lessor to an operating company is not treated as used by the lessor as an integral part of a QPA, which would preclude QPP treatment at the lessor level. Notice 2026-16, however, provides exceptions where the lessor and lessee are members of the same consolidated group or are commonly controlled pass‑through entities, allowing the property to be treated as used in a QPA despite the self‑rental structure.

These rules are particularly important for groups that hold real estate in a separate entity from the manufacturing or production operating company, as the exception may permit QPP treatment where common ownership of at least 50% or more exists, subject to the detailed conditions in the Notice.

Mixed‑use facilities and allocation methodologies

Many facilities will have both qualifying production space and non‑qualifying space. In those cases, taxpayers must allocate basis and related costs between QPP and non‑QPP uses under a reasonable method consistent with the Notice.

Guidance indicates that acceptable approaches can include methods analogous to cost segregation (identifying and costing components directly tied to production areas) and square‑footage‑based allocations, where the share of basis assigned to QPP is determined based on the ratio of production‑use area to total area. Headcount or time‑based methods may not be used to allocate certain costs where labor usage is the primary driver of economic consumption under this Notice.

Taxpayers should ensure that any chosen allocation method is applied consistently, produces a reasonable reflection of production versus non‑production use, and is supportable under examination in light of the Notice’s integral‑part and de minimis rules.

State conformity considerations

State treatment of the new QPP bonus regime is not uniform. Some states, such as Virginia, do not adopt the bonus depreciation provisions enacted by the 2025 federal legislation and therefore do not follow the federal treatment of QPP under the Notice.

Planning observations

With the Notice in effect, production‑oriented taxpayers contemplating new or expanded facilities should:

• Evaluate whether proposed projects are designed around substantial‑transformation activities and can satisfy the QPA standard.
• Structure construction timelines to fit within the post‑January 19, 2025, construction‑begin date and, where applicable, the 10% self‑construction safe harbor.
• Consider the impact of existing or contemplated ADS/IRC § 163(j) elections on QPP eligibility.
• Review entity structures, including real‑estate holding and self‑rental arrangements, to assess whether they can fit within the consolidated‑group or common‑control exceptions.
• Develop contemporaneous allocation methodologies and facility‑use documentation to support QPP percentages, especially where the 95% de minimis test is not met.

As taxpayers evaluate new or expanded production facilities, understanding the requirements of IRS Notice 2026-16 will be important for maximizing available tax benefits and avoiding unintended disqualification. If you have questions about how this guidance may apply to your organization, contact your Keiter Opportunity Advisor | Email | Call 804.747.0000