The other day I was underneath my 85 300D Turbo when I saw a substantial chunk of black undercoating peeling off the area near where the painted finish meets the black undercoating. (Near the front door drain hole)

Whats the best way to treat this? I had the car repainted; I love it. I rebuilt the engine. Should I just ignore it; treat it with rust converter, or take it to the body shop?

I have a similar body rot on my W115. If you live in a wet enough climate, it will eventually take out the entire panel. The belly pan is not that expensive, try K&K manufacturing:

http://www.kkmfg.com/

Though the website does not show it, Tim does have W123 panels and rubber seals, too. Of course, rust-proofing and welding the new panel in place can be pricey. Good luck! Andrew Seidel.

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86 560SEC
85 500SEC Lorinser
83 300D Turbo
75 240D

Well, don't ignore it (if you want to keep the car). At the minimum, you should go after it with rust converter. Go under there with a wire brush & rust converter. It may take considerable scraping to find out how extensive the rust is. I would usually expect to coat it with rust converter and keep checking it to make sure it doesn't spread. After some point, it would be body shop time.

Note that a lot of body shops hate rust converter--they think it makes their job harder.