Immediate deductions for capital investment can raise project returns enough to move some investments above a company’s minimum required rate of return. Across 15 hypothetical US projects, full cash flow-based expensing increased the average internal rate of return by 1.57 percentage points compared with depreciation and amortization, while the cost-recovery changes in the One Big Beautiful Bill Act raised the average by 0.88 percentage points.
Capital investment falls into three broad categories:
- Equipment, including machinery, computers, tools, fixtures, and production systems
- Structures, including factories, offices, warehouses, stores, hotels, and apartment buildings
- Intellectual property, primarily research and development, but also software and artistic or entertainment originals
How delayed deductions penalize investment
Businesses generally pursue a project when its expected internal rate of return, or IRR, exceeds the company’s hurdle rate. The IRR is the discount rate at which the present value of future project cash flows equals the upfront investment.
Taxes affect that calculation because investment deductions received in future years are worth less than deductions received immediately.
For example, consider a $1,000 computer system deducted in equal amounts over five years. The company claims a $200 deduction annually. At a 21 percent tax rate, each deduction produces $42 in nominal tax savings, for a total of $210.
Using a 7 percent annual discount rate, however, the present value of those tax savings is only $184.26. The delay therefore creates a $25.74 tax penalty relative to an immediate deduction.
Under full expensing, the company deducts the entire $1,000 immediately and receives the full $210 tax benefit without a timing penalty. Immediate expensing removes the penalty created by delayed deductions; it does not by itself provide a tax subsidy.
Whether the improvement changes an investment decision depends on the project’s IRR and the company’s hurdle rate. Hurdle rates vary between companies, over time, and according to project risk.
US cost-recovery rules after the OBBBA
The One Big Beautiful Bill Act of 2025 changed the treatment of several major investment categories:
- Domestic R&D can be fully deducted when incurred.
- Foreign R&D remains subject to 15-year amortization.
- Eligible equipment receives permanent 100 percent bonus depreciation when placed in service.
- Residential rental structures are generally deducted over 27.5 years.
- Nonresidential structures are generally deducted over 39 years.
- Certain manufacturing structures qualify for temporary full expensing.
To qualify as manufacturing structures, facilities must begin construction after January 19, 2025, and before January 1, 2029. They must enter service after July 4, 2025, and before January 1, 2031.
Determining what qualifies as production property can be difficult. The temporary eligibility period may also be too short for projects with long planning, permitting, and construction schedules, such as semiconductor fabrication plants.
Case-study approach
The analysis examined 15 hypothetical projects in four groups:
- Energy and supply-chain infrastructure: a utility-scale natural gas plant, natural gas pipeline, package sorting facility, and solar farm
- Manufacturing: an aerospace parts factory expansion, gas turbine factory, and steel minimill
- Technology: a data center, semiconductor fabrication plant, warehouse robotics R&D project, and new drug development
- Services: a quick-service restaurant, supermarket, apartment building, and limited-service hotel
Each project was tested under five cost-recovery scenarios:
- R&D amortization and Modified Accelerated Cost Recovery System depreciation for equipment and structures
- Immediate domestic R&D deductions, with MACRS depreciation for physical assets
- Immediate deductions for R&D and equipment, with structures depreciated
- Full expensing for all assets when placed in service
- Full cash flow-based expensing when investment spending occurs
The final scenario differs from normal placed-in-service rules. Large projects may incur costs years before the resulting asset begins generating revenue. Even when an asset qualifies for expensing, requiring the deduction to wait until the facility enters service reduces its present value.
Overall effect on project returns
Moving from depreciation and amortization to full cash flow-based expensing increased average project IRR by 1.57 percentage points. Most individual projects gained between one and two percentage points.
Projects with a high proportion of long-lived structures generally received the largest benefit because 39-year depreciation creates a greater timing penalty than the shorter schedules applied to equipment.
The OBBBA’s combination of domestic R&D expensing, permanent equipment expensing, and temporary manufacturing-structure expensing increased average IRR from 11.74 percent to 12.62 percent across the 15 cases.
IRR before and after the OBBBA
- Utility-scale natural gas plant: 11.93% to 13.13%
- Natural gas pipeline: 12.63% to 14.00%
- Package sorting facility: 11.71% to 12.23%
- Solar farm: 11.31% to 12.32%
- Aerospace parts factory expansion: 13.95% to 15.70%
- New gas turbine factory: 14.43% to 16.39%
- Steel minimill: 10.04% to 11.27%
- Data center: 9.77% to 10.56%
- Semiconductor fabrication plant: 12.46% to 13.53%
- Warehouse robotics R&D: 14.90% to 15.62%
- New drug development: 14.98% to 15.44%
- Quick-service restaurant: 9.11% to 9.48%
- Supermarket: 9.86% to 10.32%
- Apartment building: 9.51% to 9.75%
- Limited-service hotel: 9.45% to 9.55%
The average 0.88-percentage-point increase represents slightly more than half of the potential gain identified under full cash flow-based expensing for every asset category.
Energy and supply-chain projects
Utility-scale natural gas plant
The hypothetical project is a 627-megawatt combined-cycle natural gas plant with an upfront capital cost of $571.8 million. It enters service halfway through Year 4 and earns $178.5 million in revenue during its first full operating year, with $99 million in operating costs.
The project has a 30-year life and an estimated residual asset value of $60 million. It also requires $20 million of major maintenance in Year 10 and $60 million of replacement generation equipment in Year 20.
Its IRR changes as follows:
- Depreciation and R&D amortization: 11.93%
- Equipment and R&D expensing: 13.13%
- Expensing for all assets when placed in service: 13.35%
- Full cash flow-based expensing: 13.68%
The plant has no associated R&D spending, so R&D expensing has no effect. Equipment expensing provides the largest gain, while cash flow-based treatment provides an additional benefit because construction spending occurs before the plant enters service.
The facility would not qualify for manufacturing-structure expensing.
Natural gas pipeline
The pipeline has a $3 billion upfront cost and connects natural gas deposits to a major distribution hub. It enters service halfway through Year 4, generates $510 million in annual revenue, and incurs $100 million in annual operating costs.
Major maintenance and equipment replacement costing $540 million occur in Years 12, 21, and 30. The project lasts 40 years and retains an estimated residual value of $300 million.
Its IRR rises from 12.63 percent under depreciation to:
- 13.95% with equipment and R&D expensing
- 14.00% with all assets expensed when placed in service
- 14.29% under cash flow-based expensing
Equipment expensing produces the largest immediate gain. Cash flow-based expensing adds more than structures expensing because substantial investment occurs before the pipeline begins operating.
Some pipeline property may qualify under the manufacturing-structures provision.
Package sorting facility
The proposed logistics facility costs $325 million, including $130 million of 39-year property. It enters service in Year 3 and produces $134.9 million in incremental cash flow from local sales and network savings, with $88 million in annual operating costs.
Its IRR increases from 11.71 percent under depreciation to:
- 12.23% with equipment and R&D expensing
- 13.16% with full placed-in-service expensing
- 13.43% with cash flow-based expensing
Structures expensing has a relatively large effect because the building represents a substantial portion of the project’s cost. The facility would not qualify for manufacturing-structure expensing.
Solar farm
The solar project has 150 megawatts of capacity and costs $225.3 million. It generates $27.76 million in annual revenue and has operating costs of approximately $3.04 million. A $13 million inverter replacement occurs in Year 16.
Its IRR increases from 11.31 percent under depreciation to:
- 12.32% with equipment and R&D expensing
- 12.38% with full placed-in-service expensing
- 12.54% with cash flow-based expensing
Equipment expensing produces most of the improvement because the project has little building-related expenditure. The analysis excludes clean electricity investment and production tax credits.
The facility would not qualify for manufacturing-structure expensing. The analysis assumes an independent power producer rather than a regulated utility.
Manufacturing projects
Aerospace parts factory expansion
The $100 million expansion includes:
- $25 million of R&D
- $63 million of equipment and other shorter-lived property
- $12 million of 39-year property
The operation produces $66 million in annual revenue and $20 million in operating cash flow. It also requires $5 million in annual R&D from Year 4 through Year 25 and $30 million of replacement equipment in Years 10 and 20.
Its IRR increases from 13.95 percent under depreciation and R&D amortization to:
- 14.53% with R&D expensing
- 15.35% with R&D and equipment expensing
- 15.70% with full placed-in-service expensing
- 15.76% with full cash flow-based expensing
R&D expensing alone moves the project above a 14 percent hurdle rate. Equipment expensing moves it above 15 percent. The project would qualify for manufacturing-structure expensing.
New gas turbine factory
The hypothetical factory costs $250 million, including $15 million of R&D and $59 million of 39-year property. It produces $144 million in annual revenue and $46.1 million in operating cash flow.
Its IRR changes from 14.43 percent under depreciation to:
- 14.49% with R&D expensing
- 15.53% with equipment and R&D expensing
- 16.39% with full placed-in-service expensing
- 16.53% with cash flow-based expensing
R&D is a small part of the upfront cost, so its immediate deduction has little effect. Both equipment and structures expensing materially improve returns. The project would qualify for manufacturing-structure expensing.
Steel minimill
The steel minimill costs $420 million and is designed to produce 450,000 tons of rebar annually, operating at approximately 80 percent capacity. It generates $195 million in annual revenue and $50.7 million in operating cash flow.
Its cost includes $147 million of 39-year property. The project has no R&D investment.
Its IRR rises from 10.04 percent under depreciation to:
- 10.54% with equipment expensing
- 11.27% with full placed-in-service expensing
- 11.56% with cash flow-based expensing
Structures expensing produces a larger gain than equipment expensing and moves the project above an 11 percent hurdle rate.
The facility would qualify for manufacturing-structure expensing. Interim guidance distinguishes between warehouse space used for raw materials, which may qualify, and space used to store completed products, which does not.
Technology projects
Data center
The data center costs $1 billion, including:
- $650 million of five-year property
- $80 million of 15-year property
- $270 million of 39-year property
It generates $220 million in annual revenue and $180 million in operating cash flow. Server and chip replacements cost $580 million in Year 8 and $642 million in Year 13.
Its IRR increases from 9.77 percent under depreciation to:
- 10.56% with equipment expensing
- 11.24% with full placed-in-service expensing
- 11.37% with cash flow-based expensing
Equipment expensing moves the project above a 10 percent hurdle rate, while structures expensing moves it above 11 percent. Data centers do not qualify under the manufacturing-structure provision.
Semiconductor fabrication plant
The advanced memory-chip factory costs $26 billion and is designed to produce 120,000 wafers per month. Its upfront costs include:
- $6 billion of R&D
- $14 billion of five-year property
- $1 billion of seven-year property
- $3 billion of 15-year property
- $2 billion of 39-year property
The plant generates an estimated $6 billion in annual revenue and $4.2 billion in operating cash flow. It requires $3 billion of new lithography equipment every three years from Year 7 through Year 25, plus continuing R&D.
Its IRR rises from 12.46 percent under depreciation and R&D amortization to:
- 12.64% with R&D expensing
- 13.35% with equipment and R&D expensing
- 13.53% with full placed-in-service expensing
- 13.73% with cash flow-based expensing
Equipment expensing moves the project above a 13 percent hurdle rate. Cash flow-based treatment provides an additional gain because substantial spending occurs before the plant enters service.
The project would qualify for manufacturing-structure expensing. The analysis excludes the 35 percent advanced manufacturing investment tax credit for semiconductor production.
Warehouse robotics R&D
The robotics project costs $5.1 billion, consisting of $3.8 billion in R&D and $1.3 billion in equipment. The first machines enter service in Year 4, with deployment continuing through Year 6.
By Year 7, the project produces:
- $400 million in annual patent-licensing revenue
- $818 million in annual operating-cost savings
- $123 million in machine operating costs
- $1.095 billion in annual operating cash flow
Its IRR rises from 14.90 percent under R&D amortization and equipment depreciation to:
- 15.47% with R&D expensing
- 15.62% with R&D and equipment expensing
- 15.63% with cash flow-based expensing
R&D expensing provides most of the gain and moves the project above a 15 percent hurdle rate. The project has no separately allocated structure costs.
Policy options beyond the OBBBA
Make manufacturing-structure expensing permanent
The current requirement that construction begin before January 1, 2029, and the facility enter service before January 1, 2031, may exclude projects with long planning and construction cycles.
Permanent treatment would give companies more certainty and avoid pressure to accelerate projects solely to meet statutory deadlines.
Extend cost recovery to other structures
The manufacturing provision excludes most nonresidential buildings, including:
- Offices
- Retail stores
- Hospitals
- Data centers
- Hotels and other service-sector buildings
Residential rental property also remains subject to 27.5-year depreciation. Better cost recovery for apartment buildings could increase the returns to housing construction.
Immediate expensing for all structures would create a large transitional revenue cost because deductions currently spread across several decades would be brought forward.
Neutral cost recovery is an alternative. Deductions would remain spread over the existing recovery period but would be increased for inflation and a return approximating the time value of money. This can produce an economic result similar to full expensing without requiring the entire deduction upfront.
Restore expensing for foreign R&D
Domestic R&D is immediately deductible, but foreign R&D must be amortized over 15 years.
Domestic and foreign research teams may work on different parts of the same project. Penalizing investment in a foreign research team can therefore reduce the viability of a broader project involving US operations.
The source argues that restricting foreign R&D deductions does not necessarily shift the same activity to the United States. It may instead shift ownership and financing of the foreign research to non-US companies.
Address companies without sufficient taxable income
Full expensing provides less immediate value when a company has insufficient taxable income to absorb the deduction. The deduction may instead create a loss that must be carried forward, delaying the tax benefit.
Possible mechanisms include transferability, safe harbor leasing, or adjustments that preserve the value of net operating losses over time.
Transferability has been used for renewable-energy tax credits. Before its introduction, companies often relied on complex tax-equity partnerships with firms that could use the credits. Those arrangements were estimated to absorb about 20 percent of the credit value in transaction and financing costs.
Safe harbor leasing, introduced under the Economic Recovery Tax Act of 1981, allowed companies with little or no tax liability to transfer the effective use of equipment deductions to firms able to absorb them. The policy was substantially restricted in 1982.
Neutral cost recovery can also reduce the loss-position problem because deductions remain available over time while being adjusted to compensate for the delay.
Replace placed-in-service rules with cash flow treatment
Placed-in-service rules prevent companies from deducting construction spending until the resulting asset begins operating. For projects that require several years to build, this delay reduces the value of the deduction even when the completed asset qualifies for full expensing.
A cash flow-based system would permit deductions when the investment expenditure occurs.
Important limitations
The projects are representative hypotheticals, not forecasts based on confidential company data. They use simplified discounted cash flow models and hold revenue and operating costs constant while changing only tax treatment.
The analysis also assumes:
- Each company has enough taxable income from other operations to use deductions immediately.
- Inflation remains at 2 percent annually.
- Project IRRs are nominal.
- Land costs are excluded.
- Interest deductibility and financing structures are excluded.
- Corporate alternative minimum tax effects are excluded.
- Like-kind exchanges are not considered.
- Industry-specific and activity-specific credits are generally excluded.
- Residual project value is taxable under existing depreciation-recapture rules.
- MACRS calculations use the half-year convention.
A sensitivity analysis reduces each project’s operating cash flow margin by half a percentage point. In some cases, that small deterioration is enough to move a project below a particular hurdle rate, showing that tax treatment is only one of several variables affecting investment decisions.
Results for an individual hypothetical project should not be treated as an estimate for its entire industry. Cost recovery may materially affect a marginal project without producing the same change across every company or investment in that sector.
The case studies show that faster deductions generally improve project economics, particularly for investments involving long-lived structures. The OBBBA removed much of the cost-recovery penalty for domestic R&D and equipment, but most commercial and residential structures, foreign R&D, loss-position companies, and construction spending incurred before assets enter service continue to receive less favorable treatment.
Source article: taxfoundation.org
