Partial Asset Disposition: The Deduction That Leaves With the Old Equipment

If you are replacing a roof, an HVAC system, a chiller, or any other major building component, there is a deduction most owners throw away along with the old equipment. The component you are removing still has undepreciated basis on your books. You can write off what is left of it. But only on the return for the year you replace it.

The deduction that leaves with the dumpster

Here is the situation almost every commercial owner is in without knowing it. You bought a building. For tax purposes the whole thing, roof and HVAC included, went into one 39-year bucket. Fifteen years later the rooftop units fail and you replace them for $180,000.

Two things now happen on your depreciation schedule, and only one of them is correct. You start depreciating the new units. And you keep depreciating the old units, for another twenty-four years, even though they are sitting in a scrapyard. The tax code did not require that outcome. It is simply what happens when nobody makes an election.

A partial asset disposition election fixes it. You recognize the remaining basis of the removed component as a loss in the year you removed it, and you stop carrying a dead asset.

Why almost nobody claims it

Not because it is obscure, but because of a records problem. To write off the old rooftop unit you have to know what the old rooftop unit cost. Your closing statement said one number for the entire building. It did not break out the HVAC.

So the deduction is real and available, and most owners cannot substantiate it, so their CPA reasonably declines to claim it. Solving the records problem is the whole job.

The three methods the IRS accepts

The regulations require you to start from the records described in Treasury Regulation 1.167(a)-7(c) and supplement them with a reasonable method. The IRS practice unit lists three:

1. Producer Price Index discounting. Take the replacement cost and discount it back to the year the building was placed in service, using the PPI for Finished Goods, the PPI for Final Demand, or another index designated in the Internal Revenue Bulletin. Restricted: this method is only available where the replacement is a restoration under Treasury Regulation 1.263(a)-3(k). It cannot be used for a betterment under 1.263(a)-3(j) or an adaptation under 1.263(a)-3(l). If the component was not new when the building was placed in service, the practice unit says you must reduce the figure for its age and condition.
2. Pro rata allocation. Allocate the building's unadjusted depreciable basis using the replacement cost of the disposed portion against the replacement cost of the whole asset.
3. A study allocating the cost of the asset to its individual components. That is the IRS's own phrasing, and it describes what an engineered cost segregation study produces. It is the method that does not carry the restoration-only restriction the PPI method carries, and it is the one that leaves a defensible paper trail.

The timing rule that costs people the most money

Which means the moment to deal with this is when the work is being scoped or invoiced, not fifteen months later when the return is being prepared. That is unusual in tax planning, and it is why we would rather talk to an owner during a capital project than after one.

Where it does not apply

We would rather tell you this before you pay for anything than after.

• Pre-MACRS buildings. If the building or its structural components are pre-MACRS assets, generally placed in service before 1987, the practice unit states there is no partial disposition under the disposition regulations.
• Not every capitalized cost. The IRS specifically cautions that a taxpayer cannot assume every capitalized addition to a building corresponds with a partial disposition. Some work is a repair and is deducted outright. Some is an improvement with no corresponding retirement.
• Recapture still exists. A partial disposition affects basis, and accelerating deductions generally increases what is recaptured on a later sale. See depreciation recapture for how that math actually works.
• You still need to be able to use the loss. A deduction you cannot apply against income this year is a deferral, not a win. See the section below.

A worked example

An owner buys a commercial building for $3,000,000 in 2011, of which $2,400,000 is building basis after land. In 2026 the rooftop HVAC fails and is replaced for $180,000 as a restoration.

Under a reasonable allocation, the original HVAC represented roughly 6 percent of the original building basis, about $144,000. After fifteen years of 39-year straight-line depreciation, roughly $55,000 has been taken and roughly $89,000 of basis remains. That remaining basis is what the partial asset disposition election writes off in 2026, on top of beginning to depreciate the new $180,000 unit, and on top of any acceleration a study identifies on the rest of the building.

Illustrative only. Allocation percentages, useful lives, and results vary by property, and the actual figure comes out of the study and your depreciation schedule. Not tax advice.

First, can you actually use the deduction this year?

This is the question most firms skip, and skipping it is how owners end up paying for a study that does nothing for them in the current year. A cost segregation study creates a large paper loss. Whether that loss offsets your other income this year depends on you, not on your building.

You can generally use it against active income now if you materially participate in a short-term rental (average guest stay of seven days or less, and you run it yourself rather than handing it to a property manager), if you hold Real Estate Professional status, or if you have passive income to offset. If you own a long-term rental, use a property manager, and have no passive income, the loss is still real but it suspends and releases later, usually on sale. That is a deferral, not a first-year win.

We screen for this before we quote. If your answer is the suspended case, we will tell you, and we will tell you why waiting may serve you better.

Why owners pick Basis

Every other cost segregation firm produces one kind of study, which means every other firm recommends the kind of study it produces. Basis does not produce studies. We source them, which is the only reason we can put both versions of the work in front of you and tell you honestly which one your building actually needs.

• Two real tiers, one honest tradeoff. An engineered study built by our engineering team with full audit representation and errors and omissions coverage, or a faster software-driven study at a lower fee with a thinner engineering paper trail. We recommend engineered by default and we tell you exactly what you give up if you do not take it.
• A minimum ROI, in writing, or it is free. Our study identifies at least 20x its fee in first-year deductions on commercial property, or at least 30x on a short-term rental, or you do not pay for it.
• Your number before you pay anything. Property-specific, modeled from real parcel data, not a slider on a calculator.
• We will tell you no. If you cannot use the deduction this year we say so before we quote you, not after you have paid.

Read the full comparison, including where the big national firms beat us »

If you are replacing a component this year

Send us the property address and roughly what is being replaced. We will tell you whether a partial asset disposition looks available, whether the property is pre-MACRS, and whether it is worth doing anything at all. If it is not, we will say so.

Frequently asked questions

Frequently asked questions

What is a partial asset disposition election?

When you replace a building component such as a roof, an HVAC unit, or a chiller, the old component usually still has undepreciated basis sitting on your depreciation schedule. A partial asset disposition election under Treasury Regulation 1.168(i)-8 lets you write off that remaining basis as a loss in the year you dispose of it, instead of continuing to depreciate a component that is physically gone.

When must the election be made?

The IRS practice unit is explicit: it is an annual election, made by reporting the gain or loss on a timely-filed original tax return, including extensions, for the taxable year in which the portion of the building is disposed. No specific form or election statement has to be attached. The practical consequence is that if you file that year's return without making the election, the deduction is generally gone. This is the single most expensive detail on this page.

How do I figure out what the old component was worth?

You start from the records required by Treasury Regulation 1.167(a)-7(c), then use one of the reasonable methods the regulations allow. The IRS names three: discounting the replacement cost back to the placed-in-service year using the Producer Price Index, a pro rata allocation based on replacement costs, or in its own words a study allocating the cost of the asset to its individual components.

Can I always use the Producer Price Index method?

No, and this trips people up. The IRS practice unit restricts the PPI discounting method to replacements that are a restoration under Treasury Regulation 1.263(a)-3(k). It cannot be used where the replacement is a betterment under 1.263(a)-3(j) or an adaptation under 1.263(a)-3(l). The practice unit also notes you must reduce the discounted figure for the age and condition of the component if it was not new when the building was placed in service.

Does this work on any building?

No. If the building or its structural components are pre-MACRS assets, generally placed in service before 1987, the practice unit states there is no partial disposition available under the disposition regulations. The IRS also cautions that a taxpayer cannot assume every capitalized addition to a building corresponds to a partial disposition.

Do I still get a deduction if I miss the year?

Not through this election. Missed depreciation from a prior year can often be caught up through a Form 3115 change in accounting method, but a partial asset disposition is an annual election tied to the disposition year, which is why the timing matters so much more here than it does elsewhere in depreciation. Your CPA should confirm your specific facts.

Sources

» Treasury Regulation §1.168(i)-8, disposition of MACRS property
» IRS Practice Unit, Examining a Taxpayer Electing a Partial Disposition of a Building
» Treasury Regulation §1.263(a)-3, amounts paid to improve tangible property (the restoration, betterment, and adaptation tests)
» Treasury Regulation §1.167(a)-7(c), records required for depreciable property
» Internal Revenue Code Section 179, including qualified real property under §179(f)
» Revenue Procedure 2025-32, inflation-adjusted Section 179 limits
» IRS Publication 946, How To Depreciate Property
» See Sources & Citations.