What to Expect from the New OBBBA Expensing for Manufacturing Structures

The One Big Beautiful Bill Act (OBBBA) introduced a new provision to improve the taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. treatment of investments in buildings used for manufacturing activity. However, unlike the OBBBA’s permanent improvements to the tax treatment of equipment and research and development (R&D)—which are the most powerful pro-growth provisions in the new law—expensing for manufacturing structures is temporary.

Expensing for manufacturing structures is an improvement to the tax code, but a broader, permanent version of the policy would have a much bigger impact.

What Did the OBBBA Change for Structures?

Typically, residential structures must be depreciated over 27.5 years and commercial structures (such as office buildings, warehouses, and factories) over 39 years. This means firms must spread deductions for costs out, rather than deducting costs when they are incurred. The OBBBA allows companies to fully and immediately deduct the cost of structures involved in “qualified production activity” through a new policy called expensing for manufacturing structures.

Qualified production activity is defined as “the manufacturing, production, or refining of a qualified product.” Other nonresidential properties, such as office spaces or other administrative facilities (that might adjoin a manufacturing facility), are not eligible for this immediate deduction.

The definition is not limited to explicitly manufacturing structures or factories. Taxpayers need further guidance from the Internal Revenue Service (IRS) to know exactly what types of investment will qualify.

How Big of a Tax Benefit Is Expensing for Structures?

Switching from depreciating property over 39 years to immediately deducting it is a massive improvement in tax treatment. Assuming a 3 percent discount rate and a 2 percent inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spendin rate (both of which are conservative assumptions), a company will only recover about 44 percent of its real structures costs if required to depreciate the property over 39 years. In contrast, 100 percent of the cost is recoverable if it can be immediately deducted.

Consider a new factory that will cost $10 million to build: $5 million for the equipment and $5 million for the structure. Under a status quo where equipment is eligible for 100 percent bonus depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and disco, but structures are not, the company would only be able to deduct about $7.2 million in real costs over the long run, producing phantom income of $2.8 million. Under a 21 percent corporate tax rate, that would mean an effective tax penalty of $584,000. Accordingly, introducing expensing for manufacturing structures would eliminate the penalty, lowering the after-tax cost of building the factory by almost 6 percent.

What Counts as a Structure?

The historical gap between the tax treatment of investment eligible for 100 percent bonus depreciation and 39-year assets has created an entire cottage industry: cost segregation. Some assets might look like building components, but if they have some active purpose, they can be classified as fixtures or improvements and accordingly can be eligible for existing bonus depreciation.

The new manufacturing structures provision will create similar implementation challenges as companies will seek to classify more of their structures as manufacturing structures. For example, are warehouses integral parts of the production process? Is a warehouse for raw material inputs eligible? What about a warehouse for finished products awaiting distribution?

Additionally, for structures with both eligible and ineligible spaces (say, a manufacturing plant that also includes sales offices), how are shared costs like HVAC systems allocated? As a recent National Association of Manufacturers letter noted, Treasury Department guidance should provide some clarity, but there will likely be many edge cases to be adjudicated through the courts.

Based on preliminary assumptions for what types of structures would be eligible, the expensing for manufacturing structures provision could cover roughly a quarter of investment in 39-year assets.

When Is the Policy in Effect?

Expensing for manufacturing structures is available for structures that begin construction after January 19, 2025, and before January 1, 2029. Structures also must be completed by January 1, 2031.

The two-year window for completing construction may substantially reduce the usefulness of the provision. Many major construction projects take more than two years to complete, so the policy may be an effectively active incentive for substantially less than the prescribed four years.

For example, semiconductor fabs take an average of more than two and a half years to build. To be reasonably confident a semiconductor manufacturing firm could benefit from expensing for manufacturing structures, it would need to start construction before the end of 2027 (potentially even sooner, as any delay could render the facility ineligible).

Some projects could take even longer. Policymakers in the legislative and executive branches have promoted the idea of reviving and expanding American shipbuilding capacity. A new shipyard would be eligible for manufacturing structures expensing. However, the US has little recent experience in building new shipyards, so it would be unsurprising to see new shipyards take even longer to enter revenue-generating service than semiconductor factories, potentially jeopardizing their eligibility. 

How Will the Structures Deduction Affect Growth?

The new policy removes a large penalty on some investment. However, the exact set of assets eligible for this tax treatment is uncertain at this point. Based on our preliminary analysis of assets that may be eligible for the provision, we expect a slight boost to US GDP in the short run, but minimal change in the long run, as the provision is temporary. The provision could have a significant impact on investment timing, causing investments that would have occurred just outside the provision’s eligibility timeframe to be brought forward.   

Who Will Benefit?

At the most basic level, the new structures provision will benefit manufacturers and any other businesses engaged in qualified production activity. This new provision is part of the reason the OBBBA has such large benefits for the manufacturing sector, although that is also explained by other provisions like expensing for domestic R&D and permanent bonus depreciation for equipment.   

The provision has broader benefits. A long literature shows that a large share of the corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. falls on workers. Expensing for investment in manufacturing structures eliminates a tax penalty on reinvesting in worker productivity, and workers will benefit through an increase in wages—at least in the short to medium term. However, the provision being temporary undermines long-term gains.  

Will the New Deduction Produce Negative Tax Rates?

One of the concerns historically associated with improving the tax treatment of long-lived assets is that an immediate deduction for investment would produce negative tax rates on certain types of investment. A full deduction for capital costs on its own is not a subsidy; it is simply a full deduction for costs incurred. However, a few tax provisions that, when interacting with a full deduction for costs incurred, could produce a negative tax rate.

Back in the 1980s, the last time cost recoveryCost recovery refers to how the tax system permits businesses to recover the cost of investments through depreciation or amortization. Depreciation and amortization deductions affect taxable income, effective tax rates, and investment decisions. for structures was improved, critics argued that the combination of passive losses and better tax treatment of structures produced overbuilding. Regardless of whether the overbuilding issue was real, the tax system is different now. The passive loss deduction was severely limited in the Tax Reform Act of 1986, and interest deductibility is now permanently limited to 30 percent of earnings before interest, taxes, depreciation, and amortization.  

How Could This Policy Be Better?

Expensing for manufacturing structures is a significant step forward for the tax treatment of structures, but it could be improved in several ways.

First, the deduction could be made permanent. Making the policy temporary and requiring facilities to enter service before January 1, 2031, limits its long-term impact.

It could also be expanded to cover all long-lived nonresidential structures, not just ones defined as part of qualified production activity. That would improve incentives for investment across industries, not just in manufacturing. It would also eliminate the complexity associated with cost segregation for manufacturing firms: no need to worry about exactly how much of a new factory is qualified production property versus office or sales space. An even further improvement would be to cover all structures (including residential structures like apartment buildings).

One of the challenges of extending expensing for manufacturing structures to all long-lived assets is that it would come with a significant upfront budget cost as deductions that would otherwise be spread across several decades would be brought forward. This upfront cost can be avoided using neutral cost recovery. Neutral cost recovery provides economically equivalent tax treatment to expensing: deductions are still spread over the asset’s life, but adjusted for inflation and the opportunity cost of delay.

The expensing for manufacturing structures provision is an important step in improving the tax treatment of capital investment in the United States. However, its narrow scope and temporary nature leave room for improvement. Ideally, future tax legislation would provide permanent full cost recovery for all structures.

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