The 2025 tax law lets manufacturers expense the factory itself, not just the equipment. The catch: you must own it, use it and keep using it for 10 years.
Qualified production property is the production portion of a nonresidential building that a manufacturer, refiner, or agricultural or chemical producer owns and uses itself. The owner can deduct 100% of it in the first year under Internal Revenue Code section 168(n). Congress created the deduction in Public Law 119-21 on July 4, 2025. Construction must begin after Jan. 19, 2025 and before 2029. IRS Notice 2026-16 governs, and California does not conform.
Section 168(n) at a glance
| Item | Detail |
|---|---|
| Law | IRC section 168(n), added by section 70307 of Public Law 119-21 |
| Enacted | July 4, 2025 |
| Guidance | IRS Notice 2026-16, released Feb. 20, 2026; taxpayers may rely on it until proposed regulations are published |
| What qualifies | The part of a nonresidential building used as an integral part of manufacturing, agricultural or chemical production, or refining that substantially transforms a product |
| Key dates | Construction begins after Jan. 19, 2025 and before Jan. 1, 2029; placed in service after July 4, 2025 and before Jan. 1, 2031 |
| Who can claim | The owner that conducts the production activity; landlords generally cannot, with an exception for commonly controlled lessees |
| Excluded space | Offices, administration, lodging, parking, sales, research, software and engineering, and finished-goods storage |
| Recapture | Ordinary income if the space stops being used for production within 10 years |
| California | Does not conform; the building is depreciated over its regular life on the state return |
Key takeaways
- Section 168(n), added by Public Law 119-21 on July 4, 2025, lets a manufacturer elect to deduct 100% of the production portion of a new factory instead of depreciating it over 39 years.
- Construction must begin after Jan. 19, 2025 and before Jan. 1, 2029, and the building must be placed in service before Jan. 1, 2031.
- IRS Notice 2026-16, released Feb. 20, 2026, says storage of finished goods does not qualify, while receiving and storing raw materials used in production does.
- A landlord leasing to an unrelated manufacturer cannot claim the deduction. Notice 2026-16 does let an LLC or individual leasing to a commonly controlled operating company qualify.
- If the space stops being used for production within 10 years, the benefit is recaptured as ordinary income. California allows none of the deduction.
What is qualified production property?
It is the factory space itself, newly eligible for a full first-year deduction. Factories are normally 39-year nonresidential real property, and the building shell has never been eligible for bonus depreciation. Section 70307 of Public Law 119-21 changed that for manufacturers by adding IRC section 168(n), a new 100% “special depreciation allowance” for qualified production property, per the Franchise Tax Board’s summary table.
KPMG’s summary of the enacted law describes it as “100% expensing of costs related to the construction of certain manufacturing property.” The election is optional, unavailable for leased facilities and subject to a 10-year recapture period. It sits beside, not in place of, permanent 100% bonus depreciation for equipment and site work, which our 2025 tax law overview summarizes.
Treasury and the IRS released interim rules in Notice 2026-16 on Feb. 20, 2026, according to Alvarez & Marsal. Taxpayers may rely on the notice until proposed regulations are published, if they follow it consistently.
What does a building need to qualify as qualified production property?
A building must meet every requirement in the table. Section references are to Notice 2026-16.
| Requirement | Rule | Where it comes from |
|---|---|---|
| Type of property | Nonresidential real property, or a portion of it | IRC 168(n); Notice sec. 4.01 |
| Use | Used by the taxpayer as an integral part of a qualified production activity, meaning the activity takes place in that physical space | Notice sec. 4.02(1) |
| Qualified production activity | Manufacturing, production or refining of tangible personal property that results in a substantial transformation; production is limited to agricultural and chemical production | Notice secs. 5.01, 5.02 |
| Product | Any tangible personal property except food or beverages prepared in the same building as a retail establishment where they are sold | Notice sec. 5.02(2) |
| Construction start | After Jan. 19, 2025 and before Jan. 1, 2029, using rules consistent with the bonus depreciation regulations | Notice secs. 4.01(5), 4.05 |
| Placed in service | After July 4, 2025 and before Jan. 1, 2031 | Notice sec. 4.01(7) |
| Original use | Starts with the taxpayer, or an acquired building that no one used in production from Jan. 1, 2021 through May 12, 2025, bought from an unrelated party after Jan. 19, 2025 and before 2029 | Notice secs. 4.01(4), 4.06(1) |
| Election | Statement attached to a timely filed return, including extensions; revocable only with IRS consent through a private letter ruling | Notice secs. 7.01 to 7.03 |
| Recapture | Change in use within 10 calendar years of being placed in service triggers ordinary income under section 1245 rules | Notice sec. 8 |
“Substantial transformation” means turning inputs into a distinct finished item that differs fundamentally from the original materials. The notice’s tomato sauce example shows the line. Washing and chopping tomatoes is not enough, but combining, cooking, sealing and labeling jars of sauce is.
Which parts of a plant count, and which do not?
Production space counts, and most support space does not. The statute excludes any portion used for “offices, administrative services, lodging, parking, sales activities, research activities, software development or engineering activities, or other functions unrelated to” production. Storage is split. Receiving and storing raw materials used in production counts, but finished-product storage is not an activity essential to production. A distribution warehouse full of finished goods does not qualify.
Two rules help. If 95% or more of a building’s space qualifies when it is placed in service, the owner may elect to treat the whole building as qualifying. And buildings on the same or contiguous land that operate together, such as a raw-materials warehouse feeding an adjacent factory, can be treated as one integrated facility.
Owners may allocate cost between qualifying and other space by any reasonable method, including square footage, cost segregation data, architectural plans or process diagrams. BDO advises that “obtaining contemporaneous documentation” of the production activity “will be a critical part of the analysis.” Our cost segregation guide covers how those studies work.
How does this apply to food processing and agriculture?
Agricultural production is one of only two kinds of production that count, but the activity must still produce a substantial transformation. The notice defines agricultural production to include raising, cultivating, irrigating and harvesting crops and raising livestock. Cooking, blending, preserving and packaging food into a new product fits the tomato sauce example.
Simpler post-harvest steps are a gray area. The notice gives no example for sorting, hulling, drying or packing, so their treatment is unsettled for Kern nut, fruit and produce operators. Our cold storage and ag-industrial guide covers the facility side.
Can landlords, developers or tenants claim qualified production property?
Generally only the owner that runs the production activity can. Under section 4.02(3)(a) of the notice, when the taxpayer is a lessor, property used by a lessee engaged in a qualified production activity is not treated as used by the taxpayer. An investor that builds or buys a plant and leases it to an unrelated manufacturer cannot claim the deduction. The tenant cannot either, because it does not own the building.
The notice carves out two common structures. Leases between members of a consolidated group are disregarded. And a partnership, S corporation or individual that leases to a commonly controlled business is not treated as a lessor. That covers the familiar owner-user setup where the family’s real estate LLC leases the plant to the family’s operating company. The notice defines common control by reference to the related-party rules in sections 267(b) and 707(b), so the ownership threshold in a given structure turns on those rules.
What this means for build-to-suit and sale-leaseback deals
For a manufacturer building a new plant, the deduction tilts the buy-versus-lease decision toward owning, directly or through a commonly controlled entity. A third-party build-to-suit lease forfeits it. A sale-leaseback of a recently expensed plant to an outside investor raises recapture questions under the rules.
How could Section 168(n) affect Kern County manufacturing real estate?
It could matter most for new plants built by the companies that run them. Kern’s industrial base includes food processing, ag-industrial and refining operations, the kinds of activity the provision targets. The benefit goes only to new or newly repurposed production space, built or acquired within the statutory windows, that the operator owns.
Most existing Kern manufacturing buildings will not qualify on resale, because a building used in production at any time from Jan. 1, 2021 through May 12, 2025 is excluded from the used-property rule. A vacant or warehouse building converted to production by a new owner could qualify, if no one used it for production in that window and the conversion fits the rules.
Leasing remains the norm for many users, and a regional brokerage report shows 9.55% Bakersfield industrial vacancy in Q2 2026. For a manufacturer with taxable income planning a new plant, though, the federal deduction can be large enough to change the decision. For a recent example of a large Kern manufacturing project and the county incentives it received, see our Mojave Micro Mill coverage.
Does California allow the qualified production property deduction?
No. The Franchise Tax Board states that “in general, California R&TC does not conform to the OBBBA” (FTB Tax News, March 2026), and California allows neither bonus depreciation nor the new production property deduction. On the California return, the plant is depreciated over its regular life. BDO notes that many states do not conform to section 168(n).
California’s separate manufacturing incentives, such as the partial sales and use tax exemption on equipment, are covered in our article on the California manufacturing sales tax exemption.
What are the risks and open questions?
- Recapture: converting the space to warehousing, office or another non-production use within 10 calendar years triggers ordinary income. The guidance does not settle whether a sale also recaptures the full deduction, so a sale or sale-leaseback carries open questions.
- Pending regulations: final rules may differ from Notice 2026-16, though the notice allows reliance until proposed regulations are published.
- Using the loss: pass-through owners face passive activity and excess business loss limits that can delay the benefit.
- Gray areas: packing and other light post-harvest processing, mixed-use buildings near the 95% line, and construction-start documentation for projects begun in 2025.
- State taxes: California tax is computed without the deduction, so the federal and California returns differ.
Checklist for manufacturers planning a Kern County plant
- Document when physical construction began. It must be after Jan. 19, 2025 and before 2029.
- Map the floor plan into production, raw-material storage, finished goods, office, lab and other uses early in design.
- Decide who will own the building: the operating company, a commonly controlled entity or a third-party landlord.
- For an existing building, confirm in writing that no one used it for production from Jan. 1, 2021 through May 12, 2025.
- Commission a cost segregation study and keep process documentation.
- Attach the election statement to a timely filed return for the year the plant is placed in service.
- Plan for 10 years of continued production use.
Example: a 200,000-square-foot Kern food processing plant
All figures here are hypothetical. A food processor, taxed as a C corporation, begins construction of a 200,000-square-foot plant near Bakersfield in 2026 and places it in service in July 2027. The building, excluding land and equipment, costs $30,000,000. Allocating by square footage, 80% of the space is production and raw-material storage, and 20% is finished-goods cold storage, offices and a research lab.
If the company elects Section 168(n), it deducts $24,000,000 in 2027. The other $6,000,000 is 39-year property, about $70,500 in the first partial year. Without the election, the whole $30,000,000 would produce about $352,600 of first-year depreciation. At the 21% federal corporate rate, the election defers roughly $4.98 million of federal tax in year one, if the company has enough taxable income.
If the company converts the plant to a distribution warehouse in 2032, within the 10-year window, it recaptures the benefit as ordinary income. Equipment inside the plant can separately qualify for 100% bonus depreciation. The example assumes the mid-month convention.
| Space | Square feet | Allocated cost | Federal treatment |
|---|---|---|---|
| Production floor and raw-material storage | 160,000 | $24,000,000 | 100% deduction if elected |
| Finished-goods cold storage | 24,000 | $3,600,000 | 39-year depreciation |
| Offices | 10,000 | $1,500,000 | 39-year depreciation |
| Research lab | 6,000 | $900,000 | 39-year depreciation |
| Total | 200,000 | $30,000,000 | California: regular depreciation on all of it |
Frequently asked questions
What is qualified production property?
It is the part of a nonresidential building that its owner uses as an integral part of manufacturing, agricultural or chemical production, or refining that substantially transforms a product. Under IRC section 168(n), the owner can elect to deduct 100% of that portion in year one instead of depreciating it over 39 years. Construction must start after Jan. 19, 2025 and before 2029.
Does a warehouse or distribution center qualify for Section 168(n)?
Usually not. IRS Notice 2026-16 says storing finished products is not essential to production, so a distribution center does not qualify. Space that receives and stores raw materials used in production does count, and a raw-materials warehouse next to a factory on the same or contiguous land can be treated as part of one integrated facility.
Can a landlord claim the qualified production property deduction?
Generally no. Property a tenant uses is not treated as used by the landlord, so an investor leasing a plant to an unrelated manufacturer cannot claim it. Notice 2026-16 makes exceptions for leases within a consolidated group and for a partnership, S corporation or individual leasing to a commonly controlled business. That covers many family owner-user structures.
Can I buy an existing building and claim Section 168(n)?
Only in limited cases. An acquired building qualifies only if no one used it in a qualified production activity from Jan. 1, 2021 through May 12, 2025. You also must not have used it before and must buy it from an unrelated party after Jan. 19, 2025 and before Jan. 1, 2029. Converting a former warehouse to production may fit, while buying an operating factory generally will not.
What happens if I stop manufacturing in the building?
If the space stops being used for qualified production within 10 calendar years after it is placed in service and is put to another productive use, you recapture the benefit as ordinary income under section 1245 rules in the year of the change. Converting part of a plant to finished-goods storage or offices can trigger recapture for that portion.
Does California allow the qualified production property deduction?
No. California generally does not follow the 2025 federal tax law, and the Franchise Tax Board does not allow bonus depreciation or this deduction. You depreciate the building over its regular life on the state return, so your federal and California schedules differ for as long as you own it.
How do I make the Section 168(n) election?
Attach a statement titled “Statement Pursuant to Section 7 of Notice 2026-16” to a timely filed federal return, including extensions, for the year the property is placed in service. You can revoke the election only with IRS consent through a private letter ruling. A CPA can model the recapture risk and the election for a specific plant.
If you are weighing a new plant, a conversion of an existing Kern building or an owner-user structure for a production facility, we can help you compare sites and ownership options while your CPA models the tax side. Call Kern CRE at 661-885-6949 or contact us. Get Kern County CRE news monthly: subscribe to the Kern CRE report.
Sources
- Notice 2026-16: Interim Guidance on Special Depreciation Allowance for Qualified Production Property, Internal Revenue Service, February 2026.
- IRS Provides Practical Roadmap for 100% Depreciation of Qualified Production Property (Notice 2026-16), Alvarez & Marsal (Rayth Myers et al.), Feb. 23, 2026.
- IRS Provides Clarity on Bonus Depreciation for Qualified Production Property, BDO (Julie C. Robins, Karen Messner, Megan McLaughlin), March 16, 2026.
- One, Big, Beautiful Bill and the Real Estate Industry, KPMG LLP, July 10, 2025.
- Summary of Federal Income Tax Changes (Public Law 119-21, section 70307), California Franchise Tax Board.
- Tax News, March 2026 (2025 Tax Law Changes), California Franchise Tax Board, March 2026.
- 2025 Instructions for Form FTB 3885, California Franchise Tax Board, 2025.
- 26 U.S. Code 168, Accelerated cost recovery system, Legal Information Institute, Cornell Law School.
- Q2 2026 Bakersfield, CA Industrial Market Report, Lee & Associates, July 2026.
About this article
Kern CRE prepared this article with help from AI research and writing tools. An editor reviewed the draft, checked its facts against the sources linked above and edited it for accuracy and clarity. It is general information, not legal, tax, investment or financial advice; talk with a CPA or tax attorney to confirm qualification before electing.