- The new 100% first-year depreciation deduction on real property used in manufacturing, production, or refining can accelerate cost recovery of such property by decades.
- To take advantage of the benefit, taxpayers are subject to specific time requirements, prompting action sooner rather than later.
Background
House Resolution 1, commonly referred to as the One Big Beautiful Bill Act, provides a potentially monumental benefit for the construction of qualified production property (QPP). Under certain restrictions, such property may be eligible for 100% depreciation in the year it is placed in service. QPP is defined as:
- Nonresidential real property
- Used in a qualified production activity (QPA)
- Placed in service in the U.S. or its possessions
- Original use commences with the taxpayer
- Construction begins after January 19, 2025 and before January 1, 2029
- Placed in service before January 1, 2031
In general, nonresidential real property used in a trade or business is subject to a 39-year depreciable recovery period1 for tax purposes, making this new provision a decadal accelerator for projects normally requiring millions of dollars. Furthermore, in a favorable development for noncorporate taxpayers, the first-year depreciation allowance is available for alternative minimum tax purposes.
QPA is defined as the manufacturing, production,2 or refining of a qualified product. The activities must result in a “substantial transformation” of the product. A qualified product includes any tangible personal property other than food or beverage prepared and sold in the same building, e.g., restaurants.
Insight from Forvis Mazars: A manufacturing site may contain areas eligible as a QPP and other areas that are not—such as areas used for offices, sales activities, or other nonproduction activities. A cost segregation study may be needed to determine any separate costs attributable to areas of QPP for proper calculation of deductible costs under this provision.
Substantial Transformation
How substantial transformation of a qualified product will be defined will be done in forthcoming regulatory guidance. The act specifies that the guidance should be consistent with guidance provided under Internal Revenue Code Section 954(d).
Under regulations related to this section of the code, substantial transformation of personal property is demonstrated by three examples.3 First, a corporation that processes and converts wood pulp to paper. Second, a corporation that operates a machining plant to convert steel rods into screws and bolts. Third, a corporation that acquires raw tuna fish, then processes, cans, and sells it.
This substantive test is further defined, “In no event, however, will packaging, repackaging, labeling, or minor assembly operations constitute the manufacture, production, or construction of property.” (emphasis added) Three examples also accompany this provision. First, a corporation that assembles and sells engines from purchased components is not considered to engage in substantial transformation as the engine “is not significantly distinguishable from the components.” Second, a corporation that purchases assembled engines, transmissions, and other components used to assemble automobiles is likewise not determined to be engaged in substantial transformation. Third, radio parts that are packaged as radio kits sold by a corporation would also not qualify.
Insight from Forvis Mazars: One may conclude from these examples that the mere assembly of parts or superficial modifications to property would not constitute substantial transformation; rather, materials and components must be transformed into property that is functionally and materially changed from its original state.4
Existing Property Acquired Rather Than Constructed
Although definitionally, QPP requires that the property’s use commences with the taxpayer and that construction begins after January 19, 2025 and before January 1, 2029, a special rule was included in the act for existing property acquired by a taxpayer during this same period that would also qualify as QPP. The requirements are as follows:
- The property was not previously used in a QPA by anyone between January 1, 2021 and May 12, 2025.
- The property has never been previously used by the taxpayer.
- The property was not acquired from a related party.5
The statute specifies that the date of acquisition of the QPP is when a “written binding contract” has been entered into for purposes of the January 19, 2025 to January 1, 2029 required time frame. The IRS may need to specifically define what constitutes a written binding contract in the context of this statute; however, the agency has defined the term for purposes of bonus depreciation.6 The key elements of a written binding contract are defined as follows:
- Must be enforceable under state law.
- Does not limit damages to a specified amount.
- Contractual conditions may exist if not within the control of either party.
- An option to acquire or sell the property is not permitted.
How Forvis Mazars Can Help
Other nuances exist, such as a 10-year recapture provision, treatment between a lessor and lessee of QPP, and specifics about making the election. As mentioned, time requirements do exist to take advantage of this opportunity, so we encourage you to begin discussing these requirements with a professional as soon as possible. Therefore, we invite you to reach out to us so we can help you navigate the complexities and forthcoming guidance that the IRS may provide to implement this potentially beneficial new law.
- 1§168(c)
- 2Production is further defined as only including agricultural and chemical production activities.
- 3§1.954-3(a)(4)(ii).
- 4For additional examples of substantial transformation found in IRS regulations, see §§ 1.993-3, 1.250(b)-4, and 1.45X-1. For relevant court decisions, see Uniroyal, Inc. v. United States, 542 F. Supp. 1026 (Ct. Int’l Trade 1982) and Energizer Battery, Inc. v. United States, 190 F. Supp. 3d 1308 (Ct. Int’l Trade 2016).
- 5Specifically, the statute references the requirements under (2)(A), (2)(B), (2)(C), and (3) of §179(d).
- 6§1.168(k)-1(b)(4)(ii)(A)-(E).