Bonus Depreciation and Qualified Production Property Provisions Make an Excellent Tax Planning Team, Especially for Manufacturers‍

Recent tax law changes have reshaped the landscape for potential depreciation-related tax planning strategies. These strategies can have an enormous impact in an environment where the cost of acquiring and improving commercial real estate is higher than ever. The passage of Reconciliation Bill H.R. 1 brought about many significant tax law changes that directly benefit taxpayers working in the manufacturing and agriculture industries. Two such provisions offer tax advantages when building or expanding new production facilities: bonus depreciation under IRC section 168(k) has been restored back to 100% as was seen from 2018-2022, and new IRC section 168(n) provides for an elective 100% expensing of a new asset class known as qualified production property (QPP). 

QPP, as defined in section 168(n), is certain nonresidential property for which construction began after January 19, 2025, and before January 1, 2029. The property must be used as an integral part of a qualified production activity and must be placed in service prior to January 1, 2031. A qualified production activity includes the manufacturing, agricultural or chemical production, or refining of a qualified product. The tangible personal property used in the manufacturing, production, or refining of the product must undergo a substantial transformation so activities involving minor assembly, for example, will likely not qualify. The intent of this provision is to spur manufacturing growth in the U.S. Only the portion of the nonresidential property used for the actual manufacturing, production, or refining activity is eligible for the expensing election. As such, the portions of the building used for offices, administrative services, housing, parking, research, and other nonproduction functions will continue to be depreciated over 39 years. Businesses will need to develop a reasonable method of allocating the construction costs between QPP and non-QPP. The construction timeline outlined in the provision allows for advanced planning surrounding this area of business investment. Having a proactive advisor that can assist with the tax planning required to best take advantage of this election will be essential in maximizing the potential benefits. 

In addition to new construction, the expensing election under section 168(n) can be used when purchasing an existing building. To be treated as QPP, the pre-existing structure must not have been used by any person in a qualified production activity at any time during the period beginning on January 1, 2021 and ending on May 12, 2025. Properties previously owned by the taxpayer or related parties are not likely to qualify, but if the taxpayer purchases a property from an unrelated party and converts its use to a qualified production activity then the taxpayer should be able to take advantage of the expensing election as long as the property is placed in service prior to January 1, 2031. Moreover, the purchase of an existing structure to be converted to QPP proves to be an excellent opportunity due to the additional advantages of bonus depreciation. The portion used for qualified production activities would qualify for the QPP expensing election while renovations to non-production areas of the building may be treated as qualified improvement property which would be eligible for 100% bonus depreciation under section 168(k) as discussed in the following paragraph. 

Bonus depreciation under section 168(k) has returned to 100% for qualifying assets acquired after January 19, 2025. Assets that are normally depreciable over 20 years or less qualify. For many industries making sizable investments into commercial property, such as manufacturing facilities, cost segregation studies can break out assets purchased by class life and accelerate tax depreciation. For example, a portion of the total purchase price of an existing manufacturing facility could be allocable to equipment, land improvements, and other components with shorter class lives. With this approach, the allocated portion of the cost could be expensed through bonus depreciation in the year placed in service instead of over the course of 39 years.

Overall, the benefits of bonus depreciation and the new QPP deduction can be used in tandem to create a tax strategy which delivers the best overall outcome for a business’s tax situation.

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