The Partial Asset Disposition Election Under § 1.168(i)-8(d)(2)

Under § 1.168(i)-8(d)(2), a taxpayer may elect to recognize gain or loss from the disposition of a portion of an asset, including a structural component of a building, by attaching an election statement to the timely-filed (including extensions) return for the year of disposition. The election eliminates the double-depreciation problem that arises when the replacement is capitalized as an improvement under § 1.263(a)-3 while the original asset continues to be depreciated.

Mechanics

The election is made by reporting the gain, loss, or other deduction on the taxpayer’s timely-filed original federal income tax return for the year in which the portion of the asset is disposed of. The election applies to a portion of an asset that is a structural component of a building, a portion of an asset other than a structural component (e.g., a portion of a piece of equipment), or any other portion of an asset.

The disposed portion’s adjusted basis at the time of disposition is the original cost basis of the disposed portion less depreciation allowed or allowable through the date of disposition. Loss is recognized to the extent of that adjusted basis (or gain if sale proceeds attributable to the disposed portion exceed basis).

Determining the basis of the disposed portion

The regulations under § 1.168(i)-8(f)(3) permit any reasonable method consistently applied. Acceptable methods include:

• If the asset is in a general asset account: the method specified in the account rules.
• Discounted producer price index (PPI): discount the replacement cost back to the original placed-in-service date using the appropriate PPI.
• Pro rata allocation by reference to replacement cost: allocate original basis to the disposed portion using current replacement cost ratios.
• Cost segregation study: an existing cost seg gives a defensible basis allocation directly; this is the cleanest approach.

The method is consistently applied to the disposition of that portion. A cost seg study is the most audit-resilient method because the allocation predates the disposition and is supported by engineering documentation.

Pairing with capitalization of the replacement

The capitalized replacement under the BAR test of § 1.263(a)-3(k) creates a new MACRS asset. The partial disposition election simultaneously removes the disposed portion from the original UOP’s basis. The result: the original UOP’s remaining basis is reduced; future depreciation on the original UOP runs on the reduced basis; the replacement runs on its own schedule.

Without the election, the IRS’s default treatment was unclear pre-T.D. 9689; case law and CCA 200952042 had treated such replacements inconsistently. The 2014 regulations cleaned this up by making partial disposition an explicit election.

Late election relief

The election must be made on the timely-filed return for the year of disposition. Missed elections may be eligible for relief under Rev. Proc. 2014-54 (transitional) or, in some cases, § 301.9100 relief. For prior-year property where the disposition occurred before the regulations or where the election was missed, a one-time late partial-disposition election was available under Rev. Proc. 2014-54 for taxable years beginning on or after January 1, 2012 and beginning before January 1, 2015. After that window, the elective treatment is generally not available for those years; the more common path now is to make sure current-year dispositions get the timely election.

Gain or loss character

Gain or loss on the disposed portion is computed by reference to § 1245 or § 1250 as applicable to the underlying asset. For a structural component of a building disposed of via partial disposition, this is generally § 1250 property; with straight-line MACRS there is no actual § 1250 recapture, but the unrecaptured § 1250 rate of § 1(h)(1)(E) can apply to gain.

For a loss disposition, the loss is ordinary under § 165 if the original asset is used in a trade or business or for the production of income.

Interaction with the routine maintenance safe harbor

If the work is deductible under the routine maintenance safe harbor of § 1.263(a)-3(i), no partial disposition election is needed (or available, since the underlying capitalization that triggers it does not happen). The election is for replacements that are capitalized as improvements.

Practice notes

1. Memo the basis allocation method at the time. Picking the method after the fact is harder to defend.
2. Cost seg pairing. Brand-new cost seg studies should anticipate likely future component replacements (roof, HVAC) and isolate basis to those components so the partial disposition is mechanical.
3. Component definition. The election is for a portion of an asset. A roof membrane disposition leaving the roof structure in place is a partial disposition of the building structure (or roof asset). Defining the “portion” consistently matters.
4. K-1 entities. The election is made at the entity level for the disposing entity. Practitioners sometimes treat it at the partner/member level by mistake.