What are the rules for deducting the costs of building a factory after OBBBA?
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The rules for deducting the costs of building a factory after the enactment of the One Big Beautiful Bill Act (OBBBA) have changed significantly, providing new opportunities for immediate expensing of certain types of property, especially for manufacturing and production activities. Below is a comprehensive explanation of the relevant legal details, including the new provisions, their interaction with existing law, and important caveats.
1. Permanent 100% Bonus Depreciation for Most Tangible Property
General Rule:Under OBBBA, 100% bonus depreciation (full expensing) is permanently restored for qualified property acquired and placed in service after January 19, 2025. This means that, for most tangible property with a recovery period of 20 years or less (such as machinery, equipment, and certain improvements), the entire cost can be deducted in the year the property is placed in service, rather than depreciated over several years.
- Qualified property includes tangible property with a recovery period of 20 years or less, computer software, water utility property, and certain productions (film, television, live theatrical, and sound recording).
- Original use: The property must be new to the taxpayer, but there are exceptions for certain acquired property not previously used in a qualified production activity between January 1, 2021, and May 12, 2025.
2. Special 100% Expensing for Qualified Production Property (Section 168(n))
New Provision:OBBBA introduces a new elective 100% depreciation allowance under IRC §168(n) for "qualified production property," specifically aimed at manufacturing facilities.
- Qualified production property is defined as the portion of nonresidential real property used as an integral part of a qualified production activity (manufacturing, production, or refining of tangible personal property, agricultural production, or chemical production).
- Exclusions: Office space, administrative services, lodging, parking, sales, research, software development, and other non-production functions are not eligible.
- Timing: Construction must begin after January 19, 2025, and before January 1, 2029, and the property must be placed in service before January 1, 2031.
- Election: Taxpayers must elect to apply this provision for each qualifying property.
- Recapture: If the property ceases to be used in qualified production within 10 years, recapture rules apply (i.e., some of the deduction may be "recaptured" as income).
Legal Reference:- IRC §168(n), as added by OBBBA.
3. Section 179 Expensing
Increased Limits:OBBBA increases the Section 179 expensing limit to $2.5 million, with a phaseout threshold of $4 million for property placed in service after 2024. Both thresholds are indexed for inflation in future years.
- Section 179 property includes tangible personal property and certain qualified real property (such as qualified improvement property, roofs, HVAC, fire protection, and security systems) used in the active conduct of a trade or business.
- Limitation: The deduction is limited to the taxpayer’s aggregate trade or business income for the year.
4. Standard Depreciation for Non-Qualified Real Property
If the factory (or portions of it) does not qualify for the special expensing rules above (e.g., it is not used for qualified production activities, or the taxpayer does not elect the special allowance), the costs must be capitalized and depreciated under the standard rules of IRC §168:
- Nonresidential real property (i.e., most factory buildings) is depreciated over 39 years using the straight-line method and the mid-month convention.
- Improvements to existing property are depreciated as if placed in service at the time of the improvement, with the same recovery period as the underlying property.
5. Capitalization of Construction Costs
- All direct and indirect costs of constructing the factory must be capitalized under IRC §263A until the property is placed in service.
- Once placed in service, the property is eligible for the expensing or depreciation rules described above.
6. Other Considerations and Caveats
- Mixed-Use Property: Only the portion of the property used in qualified production activities is eligible for the special expensing; costs for non-production areas (offices, etc.) must be allocated and depreciated over 39 years.
- Recapture: If the property is converted to a non-qualifying use within 10 years, recapture rules may require some of the previously deducted amount to be included in income.
- Election Out: Taxpayers may elect out of bonus depreciation on a class-by-class basis.
- Section 179 vs. Bonus Depreciation: Section 179 expensing is subject to annual limits and income thresholds, while bonus depreciation is not.
7. Summary Table of Key Provisions
8. Practical Steps for Taxpayers
- Identify which portions of the factory qualify for immediate expensing under IRC §168(k) or §168(n).
- Allocate costs between production and non-production areas.
- Elect the special expensing provisions as required on the tax return.
- Track use of the property for 10 years to monitor potential recapture.
- Consider Section 179 expensing for eligible property, especially if the total investment is below the annual limit.
In summary: After OBBBA, most costs of building a factory used for manufacturing or production can be immediately expensed under the new 100% bonus depreciation or the special 100% expensing for qualified production property, provided the property meets the statutory requirements and the taxpayer makes the necessary elections. Costs for non-production areas or non-qualifying property must be depreciated over 39 years. Section 179 expensing is also available for eligible property, subject to increased limits. Careful planning and documentation are essential to maximize the available deductions and comply with the new rules.
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