A Hidden Opportunity in Property Upgrades
When you replace a major part of your rental property, like a roof, HVAC system, or plumbing, you’re likely focused on the cost of the new installation.
But what about the old asset you just removed?
Most investors miss the valuable tax opportunity in that old component.
It’s called a partial asset disposition (PAD), a tax election that must be made in the same year you replace a capitalized asset. This allows you to write off the remaining basis instead of continuing to depreciate the replaced asset over time.
For real estate investors, understanding how and when to make a PAD election maximizes tax savings every time you repair or renovate your property.
What Is a Partial Asset Disposition?
A partial asset disposition allows you to claim a deduction for the undepreciated portion of an asset you’ve replaced or disposed of.
In simple terms, if you remove part of a larger asset, such as an HVAC unit, electrical system, or roof, you can write off the remaining value of that old part instead of keeping it on your depreciation schedule.
This rule is outlined under Reg. Sec. 1.168(i)-8(d)(2) and must be applied by making the PAD election in the same tax year you dispose of the old asset.
PADs help ensure you’re not depreciating two versions of the same asset at once, which is not allowed, and can distort your books and tax outcome.
If you don’t remove the old component from your books, you’ll keep depreciating an asset that was disposed of, along with the new asset. This leaves opportunity on the table, whereas a PAD allows you to deduct the remaining basis of the old asset right away.
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Why Partial Asset Dispositions Matter for Real Estate Investors
Partial asset dispositions are often overlooked, but have a meaningful impact on your tax position and long-term planning.
Here’s why they matter:
| Avoid double depreciation. | Without a PAD election, you might continue depreciating the old asset even though it no longer exists. |
| Accelerate deductions. | Writing off the remaining basis immediately can create a sizable deduction in the year of replacement. |
| Improve record accuracy. | PADs keep your fixed asset schedule aligned with the real condition of your property. |
| Work with other strategies. | PADs often appear in tandem with cost segregation or improvement planning, creating opportunities for even more tax benefits. |
Real-World Example: Putting PADs into Practice
In a recent case study from our Tax-Savvy Investor newsletter, one client combined a partial asset disposition with a cost segregation study to maximize deductions during a major property upgrade. By coordinating the timing of both strategies, they were able to write off the remaining value of the replaced components and accelerate depreciation on the new improvements in the same tax year.
The result was a stronger immediate deduction, cleaner books, and better long-term planning for future renovations.
Want to see how the numbers worked out?
See the full breakdown in our October case study.
How to Identify PAD Opportunities
PADs aren’t limited to large commercial projects. Many residential and small multifamily properties qualify, too.
Here are common scenarios where a partial asset disposition may apply:
- Roof replacement
- HVAC or boiler system replacement
- Electrical or plumbing upgrades
- Door or window replacements
- Kitchen or bathroom upgrades
To make the election, you must be able to reasonably determine the cost of the disposed asset. That can come from receipts, invoices, or a cost segregation study that allocates values to individual building components.
How to Make a PAD Election
You must make the PAD election in the same tax year you remove or replace the asset; you can’t decide to take a PAD retroactively in future years.
To properly claim a PAD election, you’ll need clear and supportable records that show:
| What you’ll need | Why |
| The original cost and the date the old part was placed in service. | This shows what is being written off and how much depreciation has already been taken. |
| The date and cost of the replacement. | This helps verify when the new component went into service and ensures the timing of the PAD matches the replacement year. |
| The portion of the old asset being disposed of. | This identifies what part of the property is being removed, such as the roof, HVAC, or another major component, and confirms that it qualifies as a separate asset. |
These records allow your CPA to calculate the remaining undepreciated value accurately and report the PAD correctly on your tax return.
In most cases, this process is coordinated between your tax professional and a cost segregation specialist to ensure the component values and documentation align with IRS guidelines.
Remember: PADs are not automatic. The election must be intentionally made in the same tax year as the replacement or removal of the original asset.
Need help determining which property components qualify or how to document a PAD correctly? Our team can walk you through each step. Contact our team.
Common Mistakes and Misconceptions
Even experienced investors can miss PAD opportunities. Common pitfalls include:
- Not separating components in depreciation schedules at purchase or initial renovation
- Failing to elect the PAD in the year of replacement
- Assuming the write-off applies automatically
- Confusing PADs with repair vs. improvement rules (see our guide on How to Classify Repairs vs. Improvements)
Missing a PAD election can mean losing out on significant deductions that could have been claimed in the current tax year.
Integrating PADs into Your Tax Strategy
A PAD isn’t a one-off decision. It’s a tool that fits into a broader, proactive tax strategy.
Here’s how they connect with other key strategies:
Cost segregation studies.
Cost segregation breaks down a property into detailed components like cabinets, countertops, flooring, or landscaping.
That same level of detail allows you to identify which parts are being replaced and calculate what can be written off through a PAD. Used together, these strategies accelerate deductions on new improvements while immediately writing off the old ones.
Renovation planning.
Coordinating renovation timelines with your CPA ensures PAD elections occur in the same year as major replacements. This prevents missed opportunities and lets you time upgrades for when deductions will have the greatest impact.
Real Estate Professional Status (REPS) and Short-Term Rental (STR) strategies.
When PAD-related deductions generate significant losses, REPS and STR material participation can help shape the classification of the losses related to the activity.
1031 exchanges.
PADs also help keep cost basis and component tracking clean when planning a 1031 exchange. Removing disposed parts from your books before an exchange ensures your adjusted basis is accurate and avoids overstating value.
When identified early and planned alongside these strategies, PADs help you capture deductions the same year you spend money on improvements, leading to some cash back in your pocket in the form of tax savings.
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Summary
- A partial asset disposition (PAD) lets you deduct the remaining value of a replaced or disposed asset.
- PADs prevent double depreciation, sync your books to your tax return, and can meaningfully increase cash flow.
- To qualify, you must document the cost of the old asset and elect the PAD in the same year the replacement occurs.
- Coordinating PADs with cost segregation and renovation planning maximizes this tax strategy.
Make Every Upgrade Count
Upgrades don’t just improve your property; they can improve your tax position, too.
Our team helps investors identify and document partial asset dispositions as part of a proactive real estate tax strategy.
Learn more about how we help real estate investors maximize deductions: https://www.aiolacpa.com/contact/
Continue Reading
- A Real Estate Investor’s Guide to IRS Audits
- Accounting for Real Estate Investors: Why Accurate Books Matter for Tax Strategy
- Understanding Partial Asset Dispositions (PADs) for Real Estate Investors
- How to Classify Repairs vs. Improvements
- Which Hours Count for Material Participation? A Guide for Real Estate Investors
