Enhancing Partial Asset Disposition Accuracy Through Cost Segregation

Here's a scenario that happens more often than you'd think: You renovate a rental property, ripping out old flooring, outdated lighting, and worn carpet. You replace everything with premium materials. Your property looks incredible. Your tenants are happy.

But here's what's costing you thousands in unnecessary taxes, you're still depreciating the old flooring and fixtures you threw in the dumpster months ago.

Stop Depreciating Assets You Don't Even Own Anymore

The IRS actually has a solution for this... the Partial Asset Disposition (PAD) election. Some real estate investors have never heard of it. Those who have often don't know how to use it correctly. Don't just bleed that money.

In this guide, you'll discover how PAD elections work, why cost segregation makes them exponentially more powerful, and how to claim tax deductions you're probably missing right now.

TLDR:

• PAD elections lets you write off the remaining value of disposed building components.

• Cost segregation makes PAD elections more accurate and tax efficient.

• PAD must be elected in the same tax year as the disposition.

• You need a reliable method to calculate the adjusted basis, ideally supported by a cost seg study.

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What Is a Partial Asset Disposition (PAD) Election?

A Partial Asset Disposition (PAD) is a tax election outlined in the IRS Tangible Property Regulations that gives property owners the chance to recognize a loss when they replace or retire part of a capital asset.

Common Building Components Eligible for PAD Elections:

• Roofing systems – Replace an old roof and write off what's left

• Interior finishes – Drywall, paint, wallcovering

• Flooring – Carpet, tile, hardwood, vinyl

• Lighting fixtures – Interior and exterior lighting systems

• HVAC components – Individual units or ductwork

• Plumbing systems – Fixtures, pipes, drains

• Doors and windows – Entry doors, interior doors, window assemblies

• Cabinets and millwork – Kitchen cabinets, built-in shelving

• Site improvements – Parking lot sections, sidewalks, landscaping

Before the Tangible Property Regulations (TPRs) were finalized back in 2014, real estate investors had to keep depreciating old building components even after they swapped them out. The PAD election changes that.

Key takeaway:

A PAD election stops depreciation on retired components and creates an immediate deductible loss, improving your after tax cash flow.

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How Cost Segregation Enhances Partial Asset Dispositions

Cost segregation is a tax strategy rooted in engineering that dissects a property into its various components, assigning each one its own depreciation schedule. This detailed breakdown simplifies the process of identifying and valuing the parts of a building that are being disposed of, which is crucial for making accurate Partial Asset Disposition (PAD) elections.

Why You Should Combine PAD with Cost Segregation:

• Accurate Basis Allocation: Cost seg gives a defensible number for what a component originally cost.

• IRS Compliance: Cost seg studies support PADs with documentation that can withstand audits.

• Increased Write-Offs: A PAD without a cost seg study may underestimate (or entirely miss) deductions.

Example Scenario: A multifamily property owner is giving their place a luxury makeover by swapping out all the original interior doors and trim. In a previous cost segregation study $32,000 was being depreciated for these elements. Now that they’re no longer in use, the owner can take advantage of a Partial Asset Disposition to write off the remaining undepreciated value—potentially saving a significant amount on taxes.

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When Should You Elect a Partial Asset Disposition?

Timing is everything with PADs. You must make the PAD election in the same tax year the component is removed or retired. If you miss this window, you forfeit the deduction.

Ideal Times to Elect PAD:

• During or immediately after a renovation or capital improvement

  
  

• When disposing of part of a building (e.g., tearing down old walls or upgrading finishes)

  
  

• If you're demolishing a portion of a structure for redevelopment

Tip: Keep detailed renovation records and consult your CPA before year-end to ensure timely election.

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Calculating the Adjusted Basis of a Disposed Component

The adjusted basis refers to the leftover value of an asset that hasn't been depreciated yet when it's taken out of service.

Basic Calculation:

1. Determine original cost of the component (from a cost seg study or reasonable estimate).

2. Subtract depreciation taken on that component up to the year of disposition.

Formula:

Adjusted Basis = Original Allocated Cost – Accumulated Depreciation

If you've done a cost segregation study, this is easy, your report should list the original cost of individual components. If you haven’t, the IRS allows reasonable methods (e.g., engineering estimates or cost indexes), but those carry more audit risk.

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Should You Use PAD?

Partial Asset Dispositions are a powerful but underutilized tax opportunity for real estate investors. When paired with cost segregation, they allow for write-offs and improved cash flow, especially during renovations and property upgrades.

If you're planning a major renovation or recently completed one, talk to your tax advisor or cost segregation firm about performing a PAD analysis. Don't leave money on the table.

Need help with cost segregation or PAD analysis?

Find a cost seg expert for a free consultation and see how much tax you could save with strategic asset disposition planning.