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I am replacing worn yoke and flange on my transfer case, they have pitted rust and are worn down from the seals. There wasn't any any felt before the seal when I removed them (long gone I suppose) and wonder if there is any special treatment to the new felt dust washers before installation ? Oil ?

I worry they will retain water and create rust.

You can oil them with a light oil and squeeze the excess out then install them adjacent to the companion flange dust shield. If you don't oil them they burn from the rotational friction and harden up on the overheated edge.

Thank you sir, will do