The One Big Beautiful Bill Act (OBBBA) (P.L. 119-21) adds a new provision which allows taxpayers to immediately deduct 100% of the cost of certain new factories. Generally, new construction is needed to qualify but this deduction can potentially apply to certain improvements to existing factories, and certain other structures, under the right circumstances.
Specifically, this provision allows taxpayers to deduct 100% of the adjusted basis of qualified production property (QPP) in the year such property is placed in service. An affirmative election is required to claim the allowance. The election, once made, is irrevocable.
Issue: The provision raises numerous interpretive questions that Treasury has yet to provide guidance on, including:
What is considered the “start of construction”?
How are allocations made? How does the lessor rule limit the deduction?
What constitutes an “integral part” of a qualified production activity?
How is “substantial transformation” defined?
Key takeaways
The new provision could be a very valuable benefit for eligible manufacturers and producers looking to expand their U.S. production footprint (e.g., to avoid tariffs). However, timely action is required to become familiar with the rules, interpret grey areas in the law and implement the various requirements within the limited acquisition and placed in service time periods, which may be challenging given the lengthy lead times typically required to plan, finance and complete large-scale building projects. Consequently, taxpayers seeking to pursue this opportunity should act now to educate themselves on the new law and work with their Baker Tilly tax advisors to address the various practical and technical considerations of the new provision, which are discussed in this article.
Among other issues, section 168(n) does not specify when construction is considered to begin and includes numerous undefined and unclear terms, as further discussed below.
Some tax professionals are suggesting that taxpayers interpret terms under section 168(n) using guidance issued under other code sections in the interim. However, the existing rules do not address all the new terms in section 168(n) and, because they were drafted for other purposes, these rules may generate widely disparate tax outcomes that may or may not conform with Congressional intent and IRS technical positions. Thus, this approach, while potentially unavoidable in the absence of timely guidance, might lead to significant uncertainty and unwelcome controversy for taxpayers.
However, assuming no guidance is forthcoming from Treasury in the near term, taxpayers may have no choice but to rely on existing rules in other code provisions, as further discussed below. It’s important to reach out to your Baker Tilly tax advisor early with questions and live situations so they may assist you in addressing technical and procedural issues, such as are outlined in this article.
Background
“Qualified production property” is defined as the portion of any nonresidential real property that meets the following requirements:
The property must be used by the taxpayer as an integral part of a qualified production activity
The property must be placed in service in the U.S. or a U.S. territory
The original use of the property must begin with the taxpayer
The construction of the property must begin after Jan. 19, 2025, and before Jan. 1, 2029
The property must be placed in service before Jan. 1, 2031
The taxpayer must file an election to claim an immediate deduction with respect to such portion of the property. As noted, the election is irrevocable.
A “qualified production activity” generally means the manufacturing, production or refining of tangible personal property. The bill defines “production” to mean agricultural production and chemical production. An activity generally does not count as a qualified production activity unless it results in a substantial transformation of the property comprising a product.
Limitation: Any portion of a property that is used for offices, administrative services, lodging, parking, sales activities, research activities, software engineering activities or certain other functions is ineligible for this benefit.
Allocation issues: As further discussed below, taxpayers may find it challenging to identify and allocate costs between qualifying and non-qualifying activities, including for facilities, or portions thereof, that are used for more than one activity. It is unclear if limited or de minimis use of an otherwise qualified facility might cause it to be unqualified.
Summarized below are examples of typical questions raised frequently by taxpayers regarding the various aspects of the new provision, including undefined terms, exclusions, time sensitive deadline matters and the election procedures.
Undefined terms
To comply with requirements that the property be used as an “integral part” of a “qualified production activity” that “substantially transforms” a “qualified product,” taxpayers will need to address issues such as the following:
What is an integral part? The statute does not define this term, nor does there appear to be guidance in other areas of the law that might be readily adapted for purposes of the new provision. As further discussed in the next section, this raises issues as to whether the property must be used exclusively for qualified production activities or, alternatively, whether property used for multiple functions might also satisfy this requirement.
What is a qualified production activity? While the statute limits the term “production” to agricultural and chemical production, it does not provide definitions for what constitutes “manufacturing” or “refining.” Treasury might possibly rely on existing authorities under section 45X, section 199A, section 954(d)(2), section 263A, or section 613, or even former section 199, to define these terms, as well as to clarify the scope of eligible agricultural and chemical production activities. Notably, the criteria applied in these authorities to determine a production or manufacturing activity varies widely and, depending on how broadly or narrowly these factors are interpreted, may be used to exclude industries that were intended to benefit or, conversely, to improperly treat non-qualified industries or activities as eligible for the allowance. Therefore, when evaluating applicability of the special allowance, taxpayers and their advisors may encounter considerable uncertainty and potential controversy, similar to the challenges experienced by numerous software developers seeking qualification for the domestic production activities deduction (DPAD) under section 199. Taxpayers will therefore need to carefully analyze and apply available guidance to their particular facts and thoroughly document the authorities and rationale for positions taken under the new law.
As further discussed in the next section below, the government also may look to these provisions to define what does not constitute manufacturing, production, or refining, as well as what may constitute non-qualifying “minor assembly.”
What is substantial transformation? The statute directs the Treasury to issue guidance consistent with the principles in section 954(d) to apply this provision. The current section 954 regulations provide a limited number of factual examples that demonstrate the types of activities that are considered “substantial transformation” treated as manufacturing, production or construction (e.g., transforming wood pulp into paper, turning steel rods into screws and bolts and converting whole fish into canned tuna). Additionally, as noted, Treasury might possibly draw from existing authorities in section 45X, section 199A, section 954(d)(2), section 263A, section 613 or former section 199 to interpret this term. For example, the former section 199 regulations define manufacturing in part as “the combining of two or more articles,” but treat certain activities like mixing paint as non-qualifying “minor assembly” that does satisfy the “substantial transformation” standard.
Exclusions
The statute provides several important exclusions for certain property that is not eligible for special allowance. Specifically, lessor owned property doesn’t qualify even if the lessee conducts a qualified production activity, food and beverages are prepared at retail establishments are ineligible, and the portion(s) of the property not used for qualified production activities are not eligible for the allowance (e.g., areas used for offices, admin, sales, research & development (R&D) and software development or engineering activities; lodging and parking). The current lack of guidance in these areas raises questions as to how broadly or narrowly these exclusions are to be interpreted and applied in many common situations such as the following:
How is the lessor rule interpreted? One provision in section 168(n) says that “in the case of property with respect to which the taxpayer is a lessor, property used by a lessee shall not be considered to be used by the taxpayer as part of a qualified production activity.”
Thus, if a taxpayer places real property into service and leases that property to a different taxpayer that uses that property in a manufacturing activity, the property will not qualify for expensing treatment under the new allowance. However, this provision appears to exclude common leasing arrangements between members of the same consolidated tax group, which are routinely entered into for valid, non-tax reasons. For example, one member of the consolidated group may own a manufacturing facility and lease that facility to another member of the same group that conducts manufacturing activities. The enterprise may separate property ownership from operational activities for purposes of asset management and legal liability mitigation (e.g., environmental, employment-related liabilities, etc.). Failure to exempt such intercompany leasing arrangements from this restriction will likely disqualify a wide array of taxpayers that presumably were intended to benefit from the provision. The National Association of Manufacturers (NAM) has called for guidance to address this perceived oversight in its comment letter to Treasury.
Can a taxpayer that owns facilities used to process food and beverage products sold to retail customers qualify for the allowance? Like the now repealed section 199 DPAD rules, the statute provides that food and beverages prepared and sold at retail establishments are not “qualified products” eligible for the special allowance. However, it is currently unclear whether taxpayers applying the new provision might rely on section 199 guidance that permitted an allocable portion of food and beverage products sold to retail customers to be treated as “qualified products” in certain circumstances (e.g., coffee beans produced in a roasting facility that are used to prepare coffee beverages in a separate retail location operated by the same taxpayer).
How are the qualified portions of the property determined? Without additional guidance from Treasury, taxpayers may encounter difficulties allocating facility costs between qualifying and non-qualifying activities under existing cost segregation principles when facilities, or portions thereof, are used for more than one activity. For example, taxpayers may use their manufacturing line for test runs of new products, which may constitute an ineligible research activity rather than qualified production. Additionally, as noted, it is unclear if limited or de minimis use of an otherwise qualified facility might cause it to be disqualified. Taxpayers have also requested safe harbors and simplified methods for allocating facility costs between qualified and nonqualified activities to facilitate application of the rules within the tight timeframe provided under the law, as well as to minimize potential future IRS controversy.
Do expansions, rehabs and improvements to an existing building qualify for the allowance? Although the statute provides that the allowance applies to new construction and certain acquired property, questions have been posed as to whether an expansion or rehabilitation of an existing building, or any capitalized improvements related to an existing building (e.g., upgrades and non-routine maintenance) can qualify for full expensing. For example:
If a taxpayer expands or adds a new addition to an existing facility, could that cost be eligible for section 168(n) expensing?
What if an existing facility is not used in a qualified production activity, but a new addition is?
If a taxpayer adapts, refurbishes or improves an existing building to conduct qualified production activities, does that cost qualify for section 168(n) expensing?
These questions will need to be addressed by Treasury as taxpayers and their advisors eagerly await further guidance.
Time sensitive deadlines
The construction of the property must begin after Jan. 19, 2025, and before Jan. 1, 2029, and the property must be placed in service before Jan. 1, 2031. Although these deadlines may appear far off, large construction projects typically require years to plan, finance and complete, and therefore taxpayers need to act now to meet these deadlines. Additionally, satisfaction of these important milestones needs to be carefully monitored and documented to substantiate eligibility for the benefit provided under the new provision. However, several important questions have arisen in this area that taxpayers will need to address, including the following:
When does construction begin for purposes of the special allowance? In the absence of specific guidance, may a taxpayer rely on other rules that interpret this concept such as are contained in the bonus depreciation regulations under section 168(k)?
Election procedures
Unlike bonus depreciation for qualified property, which is elected by default, claiming the new temporary allowance for QPP requires an affirmative election using procedures to be issued by the Treasury.
How does a taxpayer elect to expense qualified production property? To date, the IRS has not indicated a timeframe for issuing this guidance. The National Tax specialists at Baker Tilly continue to monitor ongoing developments in the tax landscape. Subscribe to our tax communications to receive the latest insights and developments from Baker Tilly delivered straight to your inbox.
If you have questions on how the above may impact your tax situation, please reach out to your Baker Tilly tax advisor.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.
