The One Big Beautiful Bill Act (OBBBA, P.L. 119-21) permanently restored 100% bonus depreciation for qualified property acquired after January 19, 2025. Every renovation you finish in 2026 carries a second, often-overlooked tax break alongside it: the partial asset disposition election.
When you replace a roof, swap an HVAC system, or rip out flooring, the IRS lets you deduct the remaining tax basis of the components you removed, if you make the election. Many investors never claim it, and the election cannot be made on an amended or late return (Treas. Reg. §1.168(i)-8(d)(2)(iii)).
A partial asset disposition (PAD) is an annual election under Treasury Regulation §1.168(i)-8(d)(2) that recognizes a loss on the portion of a building that is retired or replaced. You carve the disposed component's basis out of the parent asset, deduct what is left as an ordinary loss in the year of disposition, and capitalize the new improvement as a separate asset.
Done correctly, a PAD turns a routine capex line item into a current-year deduction that often runs into six figures.
This article walks through what a partial disposition is, why it matters for cash flow, the three-asset tracking framework that makes the election defensible, the math on a real renovation, and the mistakes that quietly disqualify the deduction.
Key Takeaways
- A partial asset disposition lets you deduct the remaining tax basis of a building component when you replace or remove it, instead of depreciating two assets at once.
- The election is annual and irrevocable. It must be made on the timely-filed return (including extensions) for the year the component is retired (Treas. Reg. §1.168(i)-8(d)(2)(iii)).
- A PAD only applies when the work is a capitalized improvement under the BAR test (Betterment, Adaptation, Restoration). Routine repairs are already fully deductible (Treas. Reg. §1.263(a)-3).
- Track three separate assets: the original parent, the disposed component, and the new improvement.
- The disposition loss is an ordinary §1231 loss, deductible against ordinary income after netting against §1231 gains.
- When you elect the PAD, demolition and removal labor become currently deductible rather than capitalized (Treas. Reg. §1.263(a)-3(g)(2)(i)).
- Miss the election, and the disposed component's basis stays on its original 27.5- or 39-year schedule. No late or amended election is allowed.
What Is a Partial Asset Disposition?
A partial asset disposition is a tax election. It lets you deduct the leftover depreciable basis of a building component when that component is retired or replaced. In plain English: when the old roof comes off, the IRS lets you write off whatever depreciation you have not yet claimed on it.
The IRS introduced the election in the Tangible Property Regulations, finalized in 2013 and amended in 2014 (T.D. 9636; T.D. 9689). Before then, investors who replaced building components were stuck depreciating two assets in parallel for decades.
To claim a partial disposition, four conditions must hold:
- The component is part of a MACRS asset (typically the building).
- You still own the parent asset at the time the component is disposed.
- The component is actually retired, replaced, or demolished.
- The election is made on a timely-filed return, including extensions, for the year of disposition (Treas. Reg. §1.168(i)-8(d)(2)(iii)).
Component-level value adds up faster than most investors realize. R.E. Cost Seg engineering studies typically identify 20% to 40% of a commercial building's depreciable basis as 5-, 7-, or 15-year property, exactly the components most likely to be replaced during a hold (R.E. Cost Seg internal study data).
Bonus Depreciation Context: What Changed Under OBBBA
Bonus depreciation has moved aggressively over the last several years. It was 100% through 2022, then phased down to 80% (2023), 60% (2024), and 40% (early 2025) under the legacy TCJA schedule. The One Big Beautiful Bill Act, signed July 4, 2025, permanently restored 100% bonus depreciation for property acquired after January 19, 2025 (IRS, OBBBA Depreciation Guidance, 2025; IRC §168(k)).
Two important nuances for PAD planning:
- The trigger is the acquisition date, not the placed-in-service date. Property acquired on or before January 19, 2025, follows the legacy phase-down (40% bonus in 2025), even if placed in service in 2026.
- A new improvement is its own asset. When you place a new component in service during a 2026 renovation, the new asset is acquired in 2026 and qualifies for 100% bonus, regardless of when the parent building was originally acquired.
Repair or Improvement? The Test That Comes First
Before a PAD is on the table, the work must qualify as a capitalized improvement rather than a deductible repair. Treas. Reg. §1.263(a)-3 lays out the BAR test: a project is capitalized if it is a Betterment, an Adaptation to a new use, or a Restoration. Replacing a major component of a building system almost always counts as a restoration.
If the work is a repair, you deduct it fully in the current year, and there is no PAD to claim. If it is a capitalized improvement, the PAD election becomes the lever that prevents double depreciation.
One related distinction matters: §280B applies to the demolition of an entire structure, not a component swap. Removing a full building generally requires capitalization of demolition costs to land, no PAD is available. Component-level removals during a renovation do not fall under §280B.
Why This Matters: The Double Depreciation Problem
Without a PAD, you create duplicate depreciation on every renovation. You capitalize the new roof and start a fresh 27.5- or 39-year schedule. Meanwhile, the old roof keeps depreciating inside the building's original basis. You are now paying tax on phantom value that no longer exists.
The election eliminates the duplication. The disposed component leaves the books. The new component starts its own life. Cash flow improves immediately.
Example: $2M Multifamily Roof Replacement
An investor buys a $2,000,000 multifamily property in 2022. After applying a land value of 20% ($400,000), the depreciable building basis is $1,600,000. In 2026, the roof is replaced for $180,000.
- Original roof allocation: A cost seg reconstruction allocates ~4% of the building basis to the original roof. $1,600,000 × 4% = $64,000 original roof basis.
- Accumulated depreciation: 4 years of 27.5-year straight-line depreciation. $64,000 × (4 ÷ 27.5) ≈ $9,309.
- Remaining basis (PAD loss): $64,000 − $9,309 = $54,691 ordinary §1231 loss in 2026.
- Tax savings at 37%: $54,691 × 37% = $20,236 in same-year federal tax savings.
Without the election, that $54,691 would have dripped out over the next 23.5 years.
If I don't elect a PAD, do I lose the deduction forever?
In effect, yes. The election is annual and cannot be made on a late or amended return. If you miss it, the disposed component's basis stays on its original schedule and bleeds out over 23 to 38 years. Form 3115 can correct unrelated depreciation method errors on the original asset, but it cannot resurrect a missed PAD election (Rev. Proc. 2015-13).
Note that private letter rulings are binding only on the taxpayer who requested them and may not be cited as precedent by other taxpayers under IRC §6110(k)(3). The rulings cited here illustrate the IRS's reasoning in past cases, not a guaranteed outcome.
The Three-Asset Tracking Framework
A defensible partial disposition rests on tracking three distinct assets through the renovation.
Asset 1: The Original Parent
The original asset is the building (or other MACRS asset) you placed in service at acquisition. Its basis is established when you buy or build, less land. A cost segregation study at acquisition creates the component-level detail you will need years later when a component is replaced. Without that detail, every future PAD becomes a forensic exercise.
Asset 2: The Disposed Component
The disposed component is the part of the parent asset that is removed. To claim the deduction, you need its allocated original cost and its accumulated depreciation as of the disposition date. The regulations allow three methods (Treas. Reg. §1.168(i)-8(f)(3)):
- Discounted cost using a reasonable Producer Price Index to roll today's replacement cost back to the original placed-in-service year.
- Pro-rata allocation from the parent asset's basis using square footage, system percentages, or other reasonable measures.
- A study-based reasonable method, typically a cost segregation engineer's reconstruction of the original component cost.
A practical caveat: if the disposed component was previously expensed under 100% bonus depreciation (common for 5- and 15-year property acquired during the 100% bonus years), the remaining basis is zero, and there is no PAD loss to claim. PAD economics are strongest for components originally depreciated under straight-line or partially phased-down bonus rules.
Asset 3: The New Improvement
The new improvement becomes its own MACRS asset on the day it is placed in service. It has its own class life, its own recovery period, and its own bonus depreciation eligibility. Qualified Improvement Property (QIP) installed after the building was originally placed in service can qualify for 15-year recovery and bonus depreciation, but only for non-residential interior improvements, and only if the work is not an enlargement, a change to the internal structural framework, an elevator, or an escalator (IRC §168(e)(6); §168(k)).
† Residential rental improvements are generally 27.5-year SL and not QIP-eligible. QIP is limited to non-residential interior improvements that are not enlargements, structural framework, elevators, or escalators.
‡ §1231 losses net first against §1231 gains. A net §1231 loss is ordinary; a net §1231 gain is capital.
One distinction that catches residential rental investors off guard: QIP treatment and the 15-year recovery period apply only to non-residential interior improvements. Improvements to residential rental property, including multifamily units, are 27.5-year straight-line assets regardless of whether the work qualifies as a restoration under the BAR test. Multifamily and single-family rental investors still benefit from the PAD election on disposed components, but the new replacement asset will not carry bonus depreciation eligibility on the same basis a commercial property owner would expect.
How to Calculate a Partial Disposition Loss
Here is the math, end to end, with explicit assumptions.
Scenario. A high-income investor purchased a $3,500,000 non-residential office building in 2020. Land value at acquisition was 20%, or $700,000, leaving a depreciable building basis of $2,800,000. The original 2020 cost seg study used straight-line depreciation on the interior components (no bonus elected at the time). In 2026, the original interior lighting, ceiling grid, and non-load-bearing partitions are torn out and rebuilt for $240,000, plus $18,000 of removal labor. Assume a 37% federal marginal rate. The new improvements qualify as QIP under §168(e)(6) and are acquired in 2026, so they fall under OBBBA's 100% bonus regime.
Step 1: Identify the original component's basis. A cost seg reconstruction identifies the original interior improvements at approximately 5% of building basis.
$2,800,000 × 5% = $140,000 original component basis
Step 2: Calculate accumulated depreciation through the disposition year. 39-year straight line, six full years held.
$140,000 × (6 ÷ 39) = $21,538 accumulated depreciation
Step 3: Compute the remaining tax basis (the disposition loss).
$140,000 − $21,538 = $118,462 ordinary §1231 loss in 2026
Step 4: Deduct removal labor. Because the PAD is elected, Treas. Reg. §1.263(a)-3(g)(2)(i) allows the removal labor to be currently deducted rather than capitalized to the new asset.
$18,000 currently deductible removal cost
Step 5: Capitalize the new improvement. The new $240,000 of QIP is acquired in 2026, after January 19, 2025, and qualifies for 100% bonus depreciation under OBBBA (IRC §168(k)).
$240,000 × 100% bonus = $240,000 first-year deduction on the new asset
Step 6: Quantify the federal tax savings, broken out by source.
PAD loss: $118,462 × 37% = $43,831
Removal labor: $18,000 × 37% = $6,660
Bonus on new QIP: $240,000 × 37% = $88,800
Combined first-year federal tax savings = $139,291
Does a partial disposition trigger depreciation recapture?
No. Because you still own the parent asset, §1245 and §1250 recapture is computed only when the parent is ultimately sold. The PAD itself produces a §1231 loss in the disposition year, which nets against §1231 gains for the year and is generally ordinary on a net loss basis.
When Cost Segregation and Partial Dispositions Work Together
The two strategies reinforce each other. A cost segregation study done at acquisition produces the component schedule you need years later to support every PAD across the holding period. Without component-level documentation, you must reconstruct the basis under the PPI or pro-rata methods, which carry higher audit risk (see IRS Cost Segregation Audit Techniques Guide, 2022).
There is also a historical look-back angle worth knowing. Rev. Proc. 2014-54 once provided a transitional window for taxpayers to claim missed partial dispositions for prior years through Form 3115. That late-PAD window has closed. A separate accounting method change is still available for unrelated depreciation errors on the original asset under Rev. Proc. 2015-13, but it cannot revive a missed PAD election.
Example: Short-Term Rental Renovation
A short-term rental investor purchased a $1,100,000 STR in 2022. Assumptions: 18% land allocation, 37% federal rate, average guest stay of 7 days or fewer, investor materially participates under Treas. Reg. §1.469-5T. Critically, the 2022 cost seg study did not elect bonus depreciation on the components later replaced; those components have been depreciating on their normal MACRS schedules.
- Depreciable building basis at acquisition: $1,100,000 × 82% = $902,000.
- Year-4 renovation in 2026: $310,000 of kitchens, flooring, fixtures, and select 5- and 15-year property.
- Cost seg reconstruction of original components, all under straight-line MACRS (no prior bonus):
- 5-year personal property (appliances, carpet, fixtures): $80,000 basis, ~4 years of MACRS at ~72.5% cumulative → ~$58,000 accumulated, ~$22,000 remaining.
- 15-year land improvements (driveway, landscaping): $42,000 basis, ~$8,400 accumulated, ~$33,600 remaining.
- 27.5-year building components retired (cabinets, flooring inside the structure): $116,000 basis, ~$16,900 accumulated, ~$99,100 remaining.
- Total PAD loss: roughly $154,700.
- New improvements placed in service in 2026: $185,000 of bonus-eligible 5- and 15-year property under 100% bonus depreciation (acquired in 2026, so OBBBA's 100% rate applies).
Combined first-year deduction: $154,700 + $185,000 = $339,700
Federal tax savings at 37%: $125,689
If the original 2022 study had bonus-depreciated the same components down to zero basis, the PAD slice would disappear, and only the new $185,000 deduction would remain. This is the trade-off: maximizing bonus at acquisition can erode future PAD value on the same components.
Do I have to do a cost seg study to claim a partial disposition?
No, but you must use a reasonable method to document the disposed component's basis. The IRS and the Tax Court have long treated engineering-based studies as the most defensible approach (Hospital Corporation of America v. Commissioner, 109 T.C. 21 (1997); IRS Cost Segregation Audit Techniques Guide). PPI rollback or pro-rata methods can work for smaller dispositions, but they leave more room for IRS challenge.
Common Mistakes That Kill a Partial Disposition Claim
Consider a hypothetical multifamily owner who replaces 40 HVAC units in 2024 and files without electing the PAD: roughly $180,000 of current-year deductions vanish into the next two decades of slow depreciation.
The most common errors:
- Missing the election deadline. PADs must be claimed on the timely-filed return (including extensions) for the disposition year. No late elections (Treas. Reg. §1.168(i)-8(d)(2)(iii)).
- Capitalizing removal costs when you elected the PAD. When the election is made, removal labor is currently deductible (Treas. Reg. §1.263(a)-3(g)(2)(i)). Capitalizing forfeits a same-year deduction.
- Failing to reduce the parent asset's basis. The disposed component's original cost must come out of the building's ongoing depreciation schedule.
- Using an unsupported allocation method. Guessing the component basis invites disallowance on audit.
- Claiming a PAD on a property you no longer own. You must still own the parent at the time of disposition.
- Confusing PAD with abandonment. Section 165 abandonment applies when an entire asset is retired. A PAD applies to a component of an asset you still own.
- Confusing component removal with full-building demolition. §280B requires capitalization of full-structure demolition costs to land.
- Weak documentation. The audit-ready file includes the original cost allocation worksheet, the engineer's reconstruction, contractor invoices, and before-and-after photos.
What happens if I sell the property a year after claiming the PAD?
The PAD loss stays. The subsequent sale is computed using the adjusted basis of the building, which now excludes the disposed component. The new improvement is treated as its own asset on the sale, and a 1031 exchange can still be structured around the consolidated property if the timing rules are met.
When You Should Not Elect a Partial Disposition
The election is not always the right move. Five situations call for restraint.
- De minimis component basis. If the remaining basis is only a few thousand dollars, the administrative cost may exceed the benefit.
- Suspended passive losses. Passive investors without Real Estate Professional Status or STR material participation may not be able to use the loss in the current year. The deduction still has value, but the cash benefit is deferred.
- Fully bonus-depreciated components. If a prior cost seg study already wrote the disposed component down to zero, there is no remaining basis to claim.
- Nearly fully depreciated components. If the disposed component has almost no basis left, the PAD adds complexity without meaningful savings.
- State tax decoupling. Several states (including California, New Jersey, and others) do not conform to federal bonus depreciation, and a smaller number have decoupled from parts of the Tangible Property Regulations. Check the state treatment before relying on the federal number.
The General Asset Account election is a separate consideration. If a property is held in a GAA, the disposition rules differ, and a PAD may not be available in the standard form. Taxpayers in this situation should evaluate whether GAA treatment can be revoked or terminated under Treas. Reg. §1.168(i)-1(e)(3) before planning around PADs.
Can I make a partial disposition election if I'm a passive investor?
Yes. The election itself is available to any taxpayer who meets the four conditions. The resulting loss is then subject to the passive activity loss rules of §469. Investors who qualify as a Real Estate Professional or who run short-term rentals with material participation typically get current-year benefit. Pure passive investors generally see the loss suspended until passive income is available or the property is sold.
Conclusion
Every renovation is a tax event, not just a capital expense. The partial asset disposition election turns the components you tear out into a current-year deduction instead of a 39-year drip. Combined with cost segregation services and the permanent 100% bonus depreciation restored by OBBBA, the math frequently produces six-figure tax savings in the year of the work.
Three rules to remember:
- Track the original asset, the disposed components, and the new improvements as three distinct items.
- Make the election on the timely-filed return for the disposition year. No exceptions.
- Document the disposed component's basis with a defensible method, ideally an engineering-based study.
