Manufacturer Deductions: The 100 Percent Write-Off for New Factories, the Equipment, the Inventory Capitalization Rules, and the Research That Is Deductible Again

Manufacturing carries more capital than most small businesses — a building, the machines in it, and the inventory flowing through it — and the 2025 tax law aimed its largest new deduction squarely at the first of those: the production portion of a new factory can now be written off entirely in the year it is placed in service, for construction begun through 2028. Equipment already had 100 percent bonus depreciation restored. What remains complicated is the inventory: which costs must be capitalized into it, and when they come out as cost of goods sold.

Full expensing for a new factory

Nonresidential buildings are normally depreciated over 39 years. The 2025 law added a 100 percent deduction for "qualified production property" — the portion of a new building the taxpayer itself uses as an integral part of manufacturing, agricultural or chemical production, or refining of tangible personal property (activity that substantially transforms the product) — where construction begins after January 19, 2025 and before January 1, 2029, and the property is placed in service after July 4, 2025 and before January 1, 2031. Space leased to another business does not qualify. Offices, administrative space, lodging, parking, sales areas, research space, and software development or engineering space are excluded and remain 39-year property; the production floor, its structural components, and its building systems qualify. The deduction is elected, reduces basis to zero for that portion, and is recaptured as ordinary income if the building stops being used for production within ten years. A manufacturer buying an existing plant qualifies only if no one used it in qualified production at any time from January 1, 2021 through May 12, 2025, the buyer never used it before, and the purchase is not from a related party. A cost segregation study separates the qualifying production space from the rest.

Equipment and the shop floor

Machinery, tooling, forklifts, racking, and computer-controlled equipment are generally seven-year property (five-year in some industries, longer in a few heavy industries), eligible for Section 179 and for 100 percent bonus depreciation, permanent under the 2025 law for property acquired after January 19, 2025. Molds, dies, and jigs specific to a product are special tools — three-year property in many industries — and inexpensive or short-lived ones can be deducted under the materials-and-supplies or de minimis safe harbor rules. Repairs that keep a machine running are deducted; a rebuild that extends its life is capitalized. Interior improvements to an existing production building — new electrical for a line, HVAC for a clean room — are qualified improvement property, 15-year with bonus, when they are not part of a new factory's expensing election.

Inventory and the uniform capitalization rules

Manufacturers must capitalize into inventory not only materials and direct labor but, under the uniform capitalization rules of Section 263A, an allocable share of indirect costs — factory rent and utilities, indirect labor, production supervision, quality control, depreciation on production equipment, and a portion of certain administrative costs. Those costs are deducted as cost of goods sold when the finished goods sell, not when incurred. Businesses meeting the gross receipts test (average annual gross receipts for the prior three years of $32 million or less for tax years beginning in 2026; $31 million for 2025) are exempt from uniform capitalization and may follow their book inventory method, which for most small manufacturers means materials, direct labor, and factory overhead per their accounting system.

Inventory cost flow follows FIFO, LIFO, or specific identification; LIFO defers tax in rising-cost environments but requires book conformity and Form 970. Inventory can be written down to market under the lower-of-cost-or-market method (not available with LIFO), and obsolete or damaged goods can be written down to their actual selling price when they are offered for sale at that price within 30 days after the inventory date, or scrapped — a book reserve alone is not enough. Scrap and byproduct sales are income; the cost of scrapped material is already in cost of goods sold.

Research, the credit, and new products

Developing a new product or process — a new alloy, a faster line, a tooling method — is research. For tax years beginning after 2024, those domestic costs are deductible when paid or incurred under Section 174A rather than amortized over five years, and the same work can qualify for the research credit under Section 41 if it meets the four-part test: a new or improved function, grounded in engineering or science, resolving uncertainty, through experimentation. Prototype costs, engineering wages, and testing supplies are the typical qualified expenses; production after the design is settled is not. The deduction is reduced by the credit unless the reduced-credit election is made.

The qualified business income deduction and the owner

Manufacturing is not a specified service business, so a pass-through manufacturer's owners can take the 20 percent qualified business income deduction above the income thresholds ($201,750, or $403,500 on a joint return, for 2026, with the limit phasing in fully at $276,750 and $553,500), limited to the greater of 50 percent of W-2 wages or 25 percent of wages plus 2.5 percent of the unadjusted basis of depreciable property — a limit that a capital-heavy plant with a payroll often clears. The full expensing of a new factory does not reduce the property's unadjusted basis for this purpose.

The Florida layer

Florida exempts from sales tax machinery and equipment used in manufacturing at a fixed location, electricity used to run manufacturing machinery (fully exempt when at least 75 percent of a location's electricity does so, half exempt at 50 to 75 percent), and repair parts and labor for that machinery, with the exemption claimed through a certificate to the vendor. Manufacturing equipment and furnishings are reported on the tangible personal property tax return each April, with the first $25,000 exempt per return. Inventory is exempt from Florida property tax — finished goods, work in process, and raw materials that will become part of the product.

Worked example. A metal fabricator begins construction of a $4 million plant in 2026: $3.2 million of production space and $800,000 of offices and showroom. When the plant is placed in service, it elects full expensing on the $3.2 million production portion and depreciates the $800,000 balance over 39 years. It installs $1.5 million of CNC equipment, deducted under 100 percent bonus. Its gross receipts average under the $32 million threshold, so it is exempt from uniform capitalization and follows its book overhead allocation. Engineers spend $300,000 developing a new bracket design: deducted under Section 174A, and $140,000 of the wages qualify for the research credit, so the deduction is reduced by the credit amount unless the firm elects the reduced credit. Florida sales tax on the CNC purchase is avoided with the manufacturing exemption certificate.

Official sources

The Internal Revenue Code provides: “The term “qualified production property” shall not include that portion of any nonresidential real property which is used for offices, administrative services, lodging, parking, sales activities, research activities, software development or engineering activities, or other functions unrelated to the manufacturing, production, or refining of tangible personal property.” — Legal Information Institute, Cornell Law School, 26 U.S. Code § 168 - Accelerated cost recovery system, https://www.law.cornell.edu/uscode/text/26/168

The IRS explains: “Under the uniform capitalization rules, you must capitalize the direct costs and part of the indirect costs for production or resale activities. Include these costs in the basis of property you produce or acquire for resale, rather than claiming them as a current deduction.” — Internal Revenue Service, Publication 538 (01/2022), Accounting Periods and Methods, https://www.irs.gov/publications/p538

The Florida Department of Revenue explains: “This exemption is available to any business whose primary business activity at the location where the industrial machinery and equipment is used to manufacture, process, compound, or produce items of tangible personal property for sale is specified in North American Industry Classification System (NAICS) Codes (2007) 31, 32, or 33 (Manufacturing).” — Florida Department of Revenue, Sales and Use Tax Incentives, https://floridarevenue.com/taxes/taxesfees/Pages/sales_tax_incent.aspx

Related guides

• Section 179 or Bonus Depreciation: Choosing the Write-Off
• Inventory for Tax: FIFO, LIFO, and the Small Business Rule
• Section 174A: Research Costs Are Deductible Again
• Research Credit for Small Businesses: Form 6765 Guide
• Florida Tangible Personal Property Tax: Form DR-405, the April 1 Deadline, the $25,000 Exemption, and the Leasehold Improvements You Forgot to Report

Next step

Fairlight Accounting handles U.S. domestic, cross-border (U.S.–Canada), and international tax returns, plus bookkeeping, payroll, and CFO advisory. Our U.S. Tax Desk separates the production space for the expensing election and sets the inventory method a manufacturer's books can support. See pricing or book a free fit call.