The 95 Percent Line Between Expensing Your Whole Factory and Carving It Up

TL;DR: Section 168(n) lets a manufacturer expense the building itself, not just the equipment inside it. IRS Notice 2026-16, released February 20, 2026, explains how. Buried in it is a 95 percent de minimis election. Clear 95 percent of "physical space" used as an integral part of production and you deduct the whole building. Miss it and you carve out every square foot of office, parking, and sales space. The notice never defines "physical space." No gross versus usable. No mezzanines. No break rooms. The IRS's own worked example lands on exactly 95.0 percent with nothing to spare, and the election is close to irrevocable once you make it. Two more things most of the coverage missed: a building you buy can qualify, and leasing to your own operating company usually doesn't disqualify you.

Key Takeaways

• Section 168(n) allows 100 percent first-year expensing of qualified production property, added by the One Big Beautiful Bill Act and explained in Notice 2026-16.

• Two hard dates. Construction has to begin after January 19, 2025 and before January 1, 2029. The building has to be placed in service after July 4, 2025 and before January 1, 2031. Section 4.11 gives an automatic extra year on the back end for property in a federally declared disaster area.

• Used property can qualify. Section 168(n)(2)(B) opens the provision to buildings you buy, not just buildings you build, as long as nobody ran a qualified production activity inside them between January 1, 2021 and May 12, 2025.

• Leasing the building out generally disqualifies it, but sections 4.02(3)(b) and 4.02(3)(c) of the notice carve out consolidated groups and commonly controlled pass-through entities. The building-in-an-LLC structure usually survives.

• Section 4.02(2) of the notice creates a 95 percent de minimis election that lets you skip the carve-out entirely.

• The notice never defines "physical space," the thing the 95 percent test measures. Mezzanines, break rooms, and corridors are all unaddressed.

• Section 4.08(1) names square footage, cost segregation data, engineering plans, process diagrams, and construction invoices as reasonable allocation methods. It rules out employee headcount and employee time by name.

• You make the election by attaching a statement described in section 7.02 to a timely filed return. Electing out runs through line 19j of Form 4562 and a second attachment.

• The election is revocable only by private letter ruling, and Section 1245 recapture runs for 10 years.

Section 168(n), added by the One Big Beautiful Bill Act, lets a manufacturer expense the shell of the building. Same treatment the machines on the floor inside it have been getting for years. Walls, roof, slab, foundation. One hundred percent, first year, against income.

The IRS explained how it works in Notice 2026-16, released February 20, 2026. Most of the coverage since has read it as a manufacturing incentive. Read it again as a measurement problem. There's a line in it at 95 percent, and it decides whether you deduct the whole building or start cutting pieces out of the basis. The notice never defines the thing you have to measure to find out which side you're on.

Worth understanding before you pour a slab.

What does Section 168(n) actually give you?

The provision covers what the statute calls qualified production property. In plain terms, a commercial building where you make something. Manufacturing, chemical production, agricultural production, refining. Elect it and the basis comes off in year one instead of dribbling out over 39 years.

The window has a bookend on each end, and both of them bite. Construction has to begin after January 19, 2025 and before January 1, 2029. The building has to be placed in service after July 4, 2025 and before January 1, 2031. A plant that broke ground in November 2024 is out, no matter how well it fits everything else.

Watch that start date. Most summaries lead with the 2029 deadline and skip it, and it's the one that catches people.

There is one softener on the back end. Section 4.11 of the notice gives an automatic one-year extension of the placed-in-service deadline if the property sits in a federally declared disaster area, as that term is defined in section 165(i)(5), for all or part of 2030. Automatic means automatic. You claim it by saying so in the same statement you attach to the return. Nothing to request, nobody to wait on.

If you want the wider picture of how this sits alongside 100 percent bonus depreciation and the 163(j) election, I laid that out in what the One Big Beautiful Bill changed about bonus depreciation. This post goes at one piece of it.

Does the building have to be new?

No, and this is the part most of the coverage skipped. The construction-start dates make section 168(n) read like a new-construction provision. It isn't only that.

Section 168(n)(2)(B) opens a second door for property you buy. The 2025 Instructions for Form 4562 say it in one line:

"Eligible property can be either new property or certain used property."

Certain is doing work in that sentence. Four conditions have to hold. You acquired the property after January 19, 2025 and before January 1, 2029. Nobody used it as part of a qualified production activity at any point between January 1, 2021 and May 12, 2025. You didn't use the property yourself before you acquired it. And the acquisition clears the related-party rules in section 179(d)(2) and (3), so you can't buy it from a company you control or from a family member and claim it.

The second condition is the one that does the filtering, so read it slowly. It asks whether anybody ran a qualified production activity in that building during the lookback. A plant that shut down in 2019 and has been dark since can work. A distribution warehouse can work. A vacant shell can work. A factory that ran steadily through 2023 and is now changing hands cannot, because somebody was already using it exactly the way the statute is trying to encourage.

Everything else still applies. A used building has to clear the same integral part test, the same ineligible-space rules, and the same placed-in-service deadline as one you poured yourself. What the acquisition window does is stand in for the construction window, which is the only way a purchased building could ever qualify.

If you are shopping for an existing plant, that lookback is a diligence question. The seller knows the answer. Ask before you sign, not at filing.

What if you own the building in one entity and operate in another?

Most likely question to get answered wrong, and the wrong answer costs you the entire deduction.

Here's where the confusion starts. The Form 4562 instructions put the general rule flatly: "If you lease property to someone else that conducts a QPA within it, you generally do not qualify for the special depreciation allowance." The statute is just as blunt. Section 168(n)(2)(A) says that where 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."

Read only that and a lot of manufacturers will conclude they are out. Most of them aren't.

The structure I'm describing is everywhere. The building sits in an LLC. The operating company runs the plant. The LLC leases the building to the operating company. The same people own both. On the flat rule, the LLC is a lessor and loses the deduction.

Section 4.02(3)(c) of the notice says otherwise:

"If a partnership or an S corporation, referred to as a lessor pass-through entity in this notice, or an individual leases property to a commonly controlled person, then for purposes of section 4.02(3)(a) of this notice, the lessor pass-through entity or lessor individual is not treated as a lessor with respect to the property, and for purposes of section 4.02(1) of this notice, the lessor pass-through entity or lessor individual determines whether the property meets the integral part requirement by reference to the commonly controlled person's trade or business activities conducted in, or taking place within, the leased property."

Strip the cross-references out and it says this. Lease to a commonly controlled person and you are not treated as a lessor at all. You test the integral part requirement by looking at what your tenant does inside the building, which is what you wanted in the first place.

Commonly controlled has a definition, and it's a real test. The same person or group has to own 50 percent or more of the lessor entity and 50 percent or more of the tenant, counting ownership held directly or attributed under section 267(b) or section 707(b), for a majority of the taxable year. Set the ownership up sloppily and you fall out of it.

Section 4.02(3)(b) does the same job for members of a consolidated group.

So change the order of the question. Don't ask whether you're leasing the building out. Ask who is on the other side of the lease. A genuine third-party tenant disqualifies you. Your own operating company, held through a structure that clears the 50 percent test, does not.

What parts of the building don't qualify?

Section 4.07(1) of the notice tracks section 168(n)(2)(C):

"Ineligible property includes any portion of property used for offices, administrative services, lodging, parking, sales activities, research activities, software development or engineering activities, or other functions unrelated to a QPA."

Then it throws finished-goods storage on the pile.

Hold that list up against a real plant. The front office. HR. The sales bullpen. The parking lot. The room where engineers draw next year's product. The warehouse bay where finished pallets sit waiting for a truck. All of it is space inside the building envelope, and none of it rides along on the election.

One structural note for the pros. "Offices" sits first on that list and isn't modified by "unrelated to a QPA" at the end. It stands on its own.

What is the 95 percent de minimis election?

Section 4.02(2) creates it:

"If 95 percent or more of the physical space of a property satisfies the integral part requirement at the time the property is placed in service, the taxpayer may elect to treat the entire property as satisfying the integral part requirement."

Clear enough. Clear the bar and stop carving.

Now look at how the IRS illustrated it. Example 2 in section 4.12 hands you a 200,000 square foot factory. Inside it, 6,000 square feet of office and 4,000 square feet of other space that isn't part of production. That leaves 190,000. Do the division and you land on exactly 95.0 percent. The taxpayer elects, and the entire $60,000,000 of basis counts as eligible property.

Exactly 95.0. The IRS wrote its only worked example of this rule sitting right on the line with nothing to spare.

Move one interior wall. Add a thousand square feet of office and you're at 94.5 percent, the election is gone, and every foot of that office comes out of the basis. Same building. Same business. Same year. A rounding error in the space plan swings the answer.

What counts as "physical space" under the 95 percent test?

Nobody knows. The whole test runs on physical space. That phrase shows up in sections 4.02 and 5.04 and nowhere else, and the notice defines it nowhere at all. Section 3 gives you ten defined terms. This isn't one of them.

So the questions a builder asks first all go unanswered.

Gross square footage or usable? Silent. Multi-story buildings, and whether you measure footprint or total floor area? Silent. Mezzanines? The word never appears. Restrooms, break rooms, locker rooms, corridors, mechanical rooms, the maintenance shop? Not one of those words appears either.

Here's what the gap costs in real money. Take a 200,000 square foot plant where the ground floor is all production and the offices sit on a 12,000 square foot mezzanine over the packaging line. If mezzanine area counts as physical space, you're dividing 200,000 by 212,000. That's 94.3 percent, and the election fails. If it doesn't count, the ground floor is 100 percent production and you sail through. Same building. Same offices. Two completely different tax outcomes, and the notice gives you nothing to choose between them.

Break rooms are the same problem in miniature. A break room isn't an office and it isn't production floor. Which side does it land on? Does it belong in the numerator, the denominator, or neither? The notice doesn't say.

For tax pros: is there a drafting gap in the de minimis rule?

This is the part I want practitioners looking at, and I want to be careful about how far I push it.

Section 4.01 lists nine conditions for qualified production property. The integral part requirement is condition (2). "Not ineligible property described in section 4.07" is condition (9). Two separate prongs.

Section 4.02(2) cures exactly one of them. By its terms, the de minimis election lets you "treat the entire property as satisfying the integral part requirement." It says nothing about section 4.07 and nothing about condition (9). No cross-reference in either direction. Section 4.07 has no "except as provided in section 4.02(2)" language in it.

Section 7.02(3) runs the other way. It describes applying the de minimis rule "to an eligible property." Read that literally and the building clears all nine conditions first, condition (9) included, before the de minimis rule ever comes into play. That's backwards from how Example 2 works.

And Example 2 says the whole $60,000,000 is eligible anyway. Its eighth prong reads "Factory A is not ineligible property." In a building with 6,000 square feet of offices in it. No explanation offered. That line looks copied word for word out of Example 1, where the facts stated outright that the building held no ineligible property. Example 2 dropped the fact and kept the conclusion.

Where that leaves you. The IRS plainly means for the de minimis election to sweep in the office space, and Example 2 is guidance you can rely on under section 9 of the notice. I'm not telling anyone to carve offices out of a building with a valid de minimis election. Don't do that. What's missing is the operative language that gets you to the IRS's own answer, and that hole belongs in the proposed regulations.

One more detail, and it's the one that convinced me this was an oversight rather than a choice. Section 10 asks three specific questions. One on other reasonable methods for allocating basis. One on whether the industry definitions are representative. One on examples of substantial transformation. Not one of them asks about the de minimis rule or about how to measure physical space. The IRS asked for help with the arithmetic and never asked about the yardstick.

What allocation methods will the IRS accept?

For everyone under the 95 percent line, and that's going to be most owners, section 4.08(1) sets the rules:

"A taxpayer may use any reasonable method to allocate a property's unadjusted depreciable basis between eligible property and ineligible property. For this purpose, the use of square footage, cost segregation data, architectural or engineering plans, process diagrams, or construction invoices to allocate unadjusted depreciable basis to eligible property may be a reasonable method."

Apply it consistently. Make it fit the actual facts of the building.

Then the same paragraph shuts a door:

"Using employee headcount or employee time spent on QPA activities is not a reasonable method to allocate unadjusted depreciable basis to eligible property."

That sentence does more work than it looks like it does. Headcount is the shortcut. It's what somebody reaches for when nobody has been out to the building, when you're backing into a percentage from an org chart and a payroll register. The IRS took it off the table by name.

Read what survived. Square footage. Cost segregation data. Architectural and engineering plans. Process diagrams. Construction invoices. Every one of those exists because somebody measured a physical structure. That's engineering-based cost segregation with a different label on the folder.

I hold that position on ordinary cost segregation studies and I hold it harder here. A desktop study won't produce a defensible section 168(n) allocation. Neither will a percentage borrowed off a comparable project. Somebody trained has to be in the building. On the floor, in person, drawings in hand. And they have to write down what's production and what isn't in a way that still holds up when a revenue agent reads it four years out.

How do you actually make the election on the return?

You attach a statement. There is no box to check and no form to file.

The Form 4562 instructions point you at the notice:

"To make the election and designation, attach a statement to your timely filed return (including extensions) for the tax year in which you place the eligible property in service, containing the information listed in section 7.02 of Notice 2026-16. The election and designation, once made, cannot be revoked except in extraordinary circumstances."

Section 7.02 tells you what goes in it, and the list is specific. The statement has to be titled "STATEMENT PURSUANT TO SECTION 7 OF NOTICE 2026-16" and carry your name and taxpayer identification number. Then, for each property: the street address, city, state, and ZIP code, along with a description of the property. The total unadjusted depreciable basis. If only part of the property is eligible, the dollar amount of basis allocable to that part plus a description identifying it. And the dollar amount you are designating as qualified production property, or a statement designating the entire basis.

If you are using the 95 percent de minimis rule, you declare that in the same statement. Same if you are claiming the disaster-area extension under section 4.11. One attachment carries all of it.

Timely filed is the phrase to circle. Extensions count. A late return does not.

Now the other direction, because the deduction isn't always what you want. A giant first-year write-off against a thin year can be worth less than 39 years of depreciation against fat ones. You elect out on line 19j of Form 4562, and the mechanic is not obvious:

"If you elect not to claim the special depreciation allowance for qualified production property, include the deduction for MACRS depreciation for this property in the total reported on line 19j and enter 'See attachment' in the bottom margin of the form. On the attached statement identify the property as 'QPP' and indicate the amount of MACRS depreciation claimed for this property."

Two attachments, two opposite purposes. One elects in, one elects out. Neither one gets generated by checking a box, which means somebody has to remember to write it. Ask your preparer to show you the statement before the return goes out.

Can you undo the election if you get it wrong?

Barely. Section 7.03 makes the election revocable only by private letter ruling, only with the written consent of the Secretary, and only in extraordinary circumstances. Then it adds that if the request would let you use hindsight, you don't meet the standard. That's about as closed as a door gets.

Section 168(n) also carries a recapture rule, and it runs 10 years. Qualified production property gets treated as section 1245 property. Say it stops being used as an integral part of a qualified production activity inside that window and shifts to some other use that disqualifies it. Section 1245 recapture kicks in, and the excess of recomputed basis over adjusted basis comes back as ordinary income. Partial changes get recaptured proportionally. Turn production floor into offices in year six and you hand part of the deduction back.

Two off-ramps. The first is a switch from one qualified activity to another. Stop making tractor parts, start making pumps. Nothing disqualifying in between. No recapture.

The second is idle time. You shut the plant down for a stretch and you plan to start it back up. That's temporary, and temporary doesn't trigger it.

So the allocation you document the day the building goes into service is the one you live with. There's no amended return to fix a lazy number.

Your playbook

Find out where you actually sit on 95, while the drawings are still editable. Anywhere between 93 and 97 percent, the location of an interior wall stops being an architectural preference and becomes a tax position. That conversation belongs in design review, not on the return.

Decide who's measuring before you need the number. Ask any firm you're considering whether a person will be physically inside the building. If the answer involves photos, video, or a questionnaire, keep looking.

If you're buying instead of building, run the lookback before you sign. Section 168(n)(2)(B) can qualify an existing building, but only if nobody used it in a qualified production activity between January 1, 2021 and May 12, 2025. The seller knows the answer. That belongs in diligence, not in a footnote on the return.

Check who's on the other side of your lease before you count yourself out. Building in one entity, operations in another, same owners on both sides. That structure usually still qualifies under section 4.02(3)(c). A lease to a genuine third party does not.

Write the method down now, not at filing. Section 4.08 wants it applied consistently and matched to the facts. Consistency is a lot easier to show when the memo predates the answer. And the election statement itself has to ride along on a timely filed return, extensions included, so put it on the same calendar.

Check both construction dates against your schedule. Break ground after January 19, 2025 and before January 1, 2029. In service before January 1, 2031. Two dates, both hard.

Ask the mezzanine question out loud. Upper-level space, shared space, anything that's neither production floor nor obviously office. Under a 95 percent test that ambiguity is the whole ballgame. Get it identified and documented instead of assumed.

My father was a CPA. He told me tax evasion is a crime but tax avoidance is mandatory. Congress wrote section 168(n) on purpose, for exactly this. The only thing standing between a manufacturer and the whole deduction is whether somebody bothered to measure the building right.

Frequently Asked Questions

What is Section 168(n) qualified production property?

It's the One Big Beautiful Bill Act rule that lets you expense a factory in year one. Not the equipment. The building. It has to be nonresidential and used for manufacturing, production, or refining. Construction has to start after January 19, 2025 and before January 1, 2029. The building has to go into service after July 4, 2025 and before January 1, 2031.

Can you claim Section 168(n) on a building you buy instead of build?

Yes, under a separate test. Section 168(n)(2)(B) covers used property, and the Form 4562 instructions confirm that eligible property can be new or certain used property. Four things have to hold. You acquired it after January 19, 2025 and before January 1, 2029. Nobody used it as part of a qualified production activity between January 1, 2021 and May 12, 2025. You didn't use it yourself before you acquired it. And the acquisition clears the related-party rules in section 179(d)(2) and (3).

Does leasing the building to your own operating company disqualify Section 168(n)?

Usually not, even though the general rule sounds like it does. Section 4.02(3)(c) of Notice 2026-16 says a partnership, an S corporation, or an individual that leases property to a commonly controlled person is not treated as a lessor at all, and instead tests the integral part requirement by what the tenant does inside the building. Commonly controlled means the same person or group owns 50 percent or more of both sides, counting attribution under sections 267(b) and 707(b), for a majority of the taxable year. Section 4.02(3)(b) does the same thing for consolidated groups. A lease to a genuine third party is still disqualifying.

Does Notice 2026-16 define "physical space" for the 95 percent test?

No. The election in section 4.02(2) turns on the share of "physical space" that meets the integral part requirement. The notice never defines the phrase. Gross square footage or usable? It doesn't say. Mezzanines and multi-story buildings? Not addressed. Break rooms, hallways, restrooms, and mechanical rooms? You're guessing.

Can I use employee headcount to allocate basis between production and office space?

No. Section 4.08(1) rules both out by name. Employee headcount is not a reasonable method. Neither is employee time spent on qualified production. The notice does accept square footage, cost segregation data, architectural or engineering plans, process diagrams, and construction invoices.

How do you make the Section 168(n) election on your tax return?

You attach a statement to a timely filed return, extensions included. It has to be titled "STATEMENT PURSUANT TO SECTION 7 OF NOTICE 2026-16" and carry your name and taxpayer identification number, then for each property the address, a description, the total unadjusted depreciable basis, the basis allocable to the eligible portion if only part qualifies, and the dollar amount you're designating as qualified production property. The de minimis declaration and the disaster-area declaration go in the same statement. To elect out instead, report the MACRS depreciation on line 19j of Form 4562, write "See attachment" in the bottom margin, and identify the property as "QPP" on the attachment.

Is the Section 168(n) election revocable?

Almost never. Section 7.03 allows it only through a private letter ruling, with the written consent of the Secretary, and only in extraordinary circumstances. And a request that lets you use hindsight doesn't clear that bar.

How long does Section 168(n) recapture last?

Ten years. Qualified production property is treated as section 1245 property. Say the building stops being an integral part of a qualified activity inside that window and moves to a disqualifying use. The excess of recomputed basis over adjusted basis comes back as ordinary income. Partial changes recapture in proportion. Two things don't trigger it. Moving to a different qualified activity is fine. So is going temporarily idle.

Do I need a separate cost segregation study for Section 168(n)?

Not separate, but the analysis has to be built for this rule. A standard study splits the building into 5, 7, 15, and 39-year components. A section 168(n) allocation has to map production zones against ineligible space and document that split well enough to survive examination. Every method the notice blesses requires somebody to measure the actual structure, which means an engineering-based study with an in-person site visit.

If you want the measurement done right

I offer a no-cost analysis through CSSI. No obligation, no pitch. If a study won't pay for itself on your building, I'll tell you that on the call instead of selling you one anyway. You don't need to gather documents first. Bring the address and tell me what you make there.

Schedule it here: https://calendly.com/david-wiener/cs

Or call 770-224-8504 and choose option two.

This article is educational and isn't tax advice. Section 168(n) turns on the specific facts of your building and your business, and Notice 2026-16 is interim guidance with proposed regulations still to come. Work through it with a professional who has read the notice.