Partial Disposition Election: Qualifying Assets, Basis, and Filing

The partial disposition election is the tax choice that lets a building owner deduct whatever adjusted basis remains on a structural component (a roof, an HVAC system, plumbing, wiring) in the year that component is physically removed, instead of leaving that cost stranded on the depreciation schedule for decades.¹ Buildings depreciate over 27.5 years for residential rental property and 39 years for nonresidential property, so without the election, the unrecovered cost of a component that no longer exists keeps depreciating alongside its replacement — a double capitalization that quietly overstates your basis and understates your current deductions.²

The mechanics are straightforward once you see the shape of them. You identify the retired component, calculate what basis remains in it, and report that basis as a loss on your return for the year the component came out. The rest of this article walks through what qualifies, how to compute the number, how to file, what to do if you missed the year, and how the election changes the tax bill when you eventually sell the building.

What Qualifies as a Partial Disposition

Three conditions have to line up. The component has to be MACRS property, meaning the building was placed in service after 1986 and used in a trade, business, or income-producing activity. Property placed in service before 1987 does not qualify.¹ The component has to have remaining adjusted basis; if it has already been fully depreciated, there is nothing left to deduct. And the component has to be genuinely gone, not repaired or patched.

Structural components include the parts that form and operate the building itself: walls, ceilings, floors, roofing, windows, doors, central heating and cooling systems (motors, compressors, pipes, ducts), plumbing fixtures, electrical wiring, and lighting fixtures.² The component must be integrated into the building rather than standalone equipment. A walk-in cooler bolted to a restaurant floor, for example, may be separately depreciable personal property rather than a structural component of the building.

Disposition happens when the component is permanently withdrawn from service. Physical replacement is the usual trigger: tearing out old plumbing and running new pipes, stripping a deteriorated roof membrane and laying a new one, pulling out an obsolete elevator. Abandonment and demolition of a specific component also count. A repair that leaves the original component in place does not.

Two Situations That Kill the Deduction

Section 280B ends the analysis if the work amounts to demolishing the structure rather than replacing a piece of it. Under that provision, any loss from demolishing a structure is added to the basis of the land rather than deducted, and the IRS practice unit specifically warns that a partial disposition cannot be recognized when the work rises to a demolition under Section 280B.³¹ Extensive gut renovations that strip a building to its shell can be recharacterized this way, at which point the loss capitalizes to land and produces no current deduction.

The second dead end is a zero-basis component. If the retired asset has no remaining basis at the beginning of the year of disposition, no loss can be calculated.¹ You also cannot use a FIFO-style workaround to substitute a later, non-zero-basis improvement as the “disposed” portion. The election only works when there is genuine unrecovered cost tied to the piece that came out.

Calculating the Basis of the Retired Component

Start with the unadjusted depreciable basis — what the component cost when the building was placed in service — then subtract all depreciation allowed or allowable on that portion through the year before the disposition. What remains is the adjusted basis and, in most cases, the deductible loss.

Original invoices are the cleanest source: closing statements, appraisals, construction contracts. Buildings bought as a lump sum rarely come with that breakdown, so the regulations accept reasonable allocation methods.

The Producer Price Index Method

When original component invoices don’t exist, the IRS accepts backcasting from current replacement cost using the Producer Price Index. You take today’s cost to replace the component and discount it back to the year the building was placed in service using the PPI commodity code that matches the component (asphalt roofing, steel pipes, HVAC equipment, and so on).¹ This method is available when the replacement qualifies as a restoration under the improvement regulations. Other options include a pro rata allocation based on replacement cost of the component versus the whole asset, or a formal engineering study.

Whichever method you use for the first partial disposition of a given asset, you have to use it consistently for all future partial dispositions of that same asset. Pick something defensible and stay with it.

Cost Segregation Studies

A cost segregation study performed by an engineer or specialized firm can identify and value individual building components upfront, which then supports every future partial disposition claim on that property. Fees generally run from a few thousand dollars for smaller buildings to $10,000 or more for large or complex properties. For a building where multiple component replacements are likely over a long hold, the study pays for itself by locking in a reliable basis allocation.

How to File the Election

You make the election by reporting the loss on a timely filed federal income tax return, including extensions, for the year the component was removed.⁴ No separate statement or election letter is required. The act of reporting is the election.

Report the gain or loss on Form 4797, in Part I, II, or III depending on the character of the asset. In the property description field, write “Partial Disposition Election.” The instructions specifically call for that label, and it flags the transaction for correct processing.⁴ Enter the acquisition date, the disposition date, and the basis you calculated. Because the old component was discarded rather than sold, the sales price is typically zero, and the full adjusted basis becomes the recognized loss.

Once filed, the election is essentially permanent. Revoking it requires a private letter ruling and the Commissioner’s consent, granted only if you acted reasonably and in good faith and revocation won’t prejudice the government’s interests.⁵ A change in accounting method cannot be used to undo it. Get the numbers right before you file.

The election is tied to the year of disposition and cannot be shifted to a different year on a regular return. The people who know that a roof was replaced in October need to tell the person preparing the return before April.

Recovering a Missed Election With Form 3115

A missed deadline is not necessarily fatal. If you failed to make the election on a timely filed return, you can recover it by filing Form 3115, Application for Change in Accounting Method, under the automatic consent procedures. The missed election is treated as a change from an incorrect method (continuing to depreciate a retired component) to the correct method (recognizing the disposition).⁶

For buildings and structural components, use Designated Change Number 205, which covers dispositions of a building or structural component under the partial disposition rules.⁷ The automatic change procedures carry no user fee. Attach the original Form 3115 to a timely filed return for the year of change and send a signed copy to the IRS National Office. The form includes a Section 481(a) adjustment that captures the cumulative effect of the missed deductions, so you get the prior-year benefit in the current year rather than losing it. Qualified small taxpayers may qualify for a reduced filing requirement.⁶

This retroactive route is one of the most valuable features of the partial disposition rules and one of the most commonly overlooked. If major systems were replaced in any open year without the election being made, Form 3115 can pull those deductions into the current year.

What the Election Does When You Sell

The benefit doesn’t stop at the annual deduction. Recognizing a partial disposition removes both the unadjusted basis and the accumulated depreciation of the retired component from the building’s records, which permanently shrinks the depreciation figure that follows the building to sale.

That matters because of unrecaptured Section 1250 gain. When a depreciated building is sold, the portion of gain attributable to accumulated depreciation is taxed at a maximum rate of 25%, higher than the long-term capital gains rate that applies to the rest of the gain.⁸ Stripping out depreciation tied to retired components over the years reduces the pool of gain subject to that 25% rate. What shifts out is taxed at the regular long-term capital gains rate, which tops out at 20%. Over a long hold, the arbitrage compounds.

Documentation the IRS Expects

The taxpayer bears the burden of proving that a partial disposition actually happened. The IRS practice unit instructs examiners to look for work orders, purchase orders, capital acquisition requests, and construction or demolition drawings that describe what was removed and what replaced it.¹ Capitalizing an improvement does not, by itself, prove that anything was disposed of. If the records show $300,000 spent on “building improvements” with nothing indicating what came out, the IRS can disallow the loss.

Keep PPI calculations, contractor invoices, before-and-after photos, and any engineering reports with your tax workpapers. These need to survive as long as the building is depreciable plus the standard statute of limitations, which for a 39-year asset means holding records for more than 40 years. Digital storage makes that feasible, but only when someone scans and files the documents at the time of the replacement. Reconstructing them years later during an audit is where most claims come apart.

1
Internal Revenue Service. Examining a Taxpayer Electing a Partial Disposition of a Building
2
Internal Revenue Service. Publication 946 – How To Depreciate Property
3
Office of the Law Revision Counsel. 26 USC 280B – Demolition of Structures
4
Internal Revenue Service. Instructions for Form 4797
5
eCFR. 26 CFR 1.168(i)-8 – Dispositions of MACRS Property
6
Internal Revenue Service. Instructions for Form 3115
7
Internal Revenue Service. List of Automatic Changes – Rev. Proc. 2024-23
8
Internal Revenue Service. Treasury Decision 8836 – Unrecaptured Section 1250 Gain