The central eligibility criterion is that the property must be used as an integral part of a QPA. The notice defines a QPA as the manufacturing, production or refining of a qualified product that results in a ‘substantial transformation.’
The guidance defines key terms and concepts, including:
Substantial transformation: This occurs when a process fundamentally changes the form or function of raw materials or components, creating a new and distinct item of tangible personal property. The notice clarifies that activities like simple packaging or minor assembly do not qualify.
Essential and related activities: The guidance recognizes that a production process is more than just the assembly line. A QPA can also include ‘essential’ activities that are critical to the completion of the product, such as the receiving and storage of raw materials, if they occur in the same property (or integrated facility) as the qualified production activity. It can also include related activities like process oversight, quality control and management of production costs.
Contract manufacturers: Whether the taxpayer is the tax owner of the qualified product is not taken into account when determining whether their activity is a QPA. This means a contract manufacturer that uses its own facility to manufacture, produce or refine a product for a customer, even if the customer owns the raw materials and the resulting finished goods, is considered to be engaged in a QPA, provided the activity results in a substantial transformation.
Consequently, if the contract manufacturer owns the nonresidential real property (the factory) and uses it as an integral part of its own QPA, that property can be eligible for the 100% QPP special depreciation allowance, assuming all other requirements are met.
Ineligible activities: The notice specifically excludes certain functions from qualifying, even if they occur in the same building. These include office and administrative services, sales, research and development, lodging and parking. Critically, the storage of finished goods is not considered an essential activity and space used for this purpose is ineligible.
Qualifying activities: QPP includes nonresidential real property in the context of manufacturing, production or refining activities. The term ‘production’ in this context is limited to activities in the agricultural or chemical industries. Guidance on the distinctions and boundaries between each of these categories is necessary, especially between manufacturing and production as many taxpayers use these terms interchangeably.
Manufacturing: The notice defines ‘manufacturing’ as a process that materially changes the form or function of tangible personal property to create a new, distinct item that cannot be readily returned to its original state.
Refining: The term ‘refining’ is defined as the purification of a substance into a more useful and higher-value product, with the notice providing numerous examples such as processing petroleum, purifying metals and processing vegetable oils.
Production: Consistent with the QPP statute, the term ‘production’ is narrowly defined to mean either ‘agricultural production’ (such as cultivating land and raising crops or livestock) or ‘chemical production’ (the formulation of products via chemical processes). Helpfully, the notice provides examples in each category as well as exclusionary activities.
Recapture risk: The benefit comes with a 10-year lookback period. If, within 10 years of being placed in service, the property ceases to be used as an integral part of a QPA, the taxpayer must recapture the tax benefit as ordinary income. The recapture rules are complex, particularly for partial changes in use and require careful monitoring of facility operations.
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