5 Common Cost Segregation Mistakes That Cost Investors Thousands

Cost segregation is a powerful tax strategy, but it's not without pitfalls. Making mistakes in your cost segregation study or implementation can leave money on the table—or worse, create problems with the IRS.

Here are the five most common cost segregation mistakes we see, and how to avoid them.

Mistake #1: Waiting Too Long to Order a Study

The Problem: Many investors wait years after purchasing a property before considering cost segregation. While look-back studies are possible, you miss out on years of accelerated depreciation and the time value of those tax savings. The Solution: Order your cost segregation study as soon as possible after acquisition. Ideally, begin the process before closing so the study is ready when you file your first tax return for the property. Pro Tip: If you're buying late in the year, you can still get the full first-year benefit as long as the property is placed in service before December 31.

Mistake #2: Using an Unqualified Provider

The Problem: Not all cost segregation studies are created equal. Some providers use generic percentages or "rules of thumb" rather than conducting proper engineering analysis. These studies may not hold up to IRS scrutiny. The Solution: Choose a provider with:

Licensed engineers or construction professionals
Experience with your property type
Clear methodology that follows IRS guidelines
References from CPAs and tax attorneys

Warning Sign: If a provider promises results without inspecting your property or reviewing detailed information, that's a red flag.

Mistake #3: Forgetting About Land Improvements

The Problem: Many investors focus only on the building's interior components (5-year and 7-year property) and overlook land improvements, which qualify for 15-year depreciation. The Solution: Make sure your study evaluates:

Parking lots and driveways
Sidewalks and patios
Landscaping and irrigation systems
Fencing and retaining walls
Outdoor lighting
Site utilities (extending to the property line)

Land improvements often represent 10-15% of total property value and are frequently missed.

Mistake #4: Not Coordinating with Your CPA

The Problem: You get a cost segregation study done, but your CPA doesn't know how to implement it, or implements it incorrectly. Some CPAs are unfamiliar with Form 3115 (for look-back studies) or bonus depreciation elections. The Solution:

Involve your CPA early in the process

Choose a cost segregation provider who offers CPA support

Make sure your CPA has experience with real estate depreciation

Review the implementation together before filing

Key Forms to Know:

Form 4562: Depreciation and Amortization
Form 3115: Application for Change in Accounting Method (for look-back studies)

Mistake #5: Ignoring the Exit Strategy

The Problem: Investors get excited about the immediate tax savings without considering the implications when they sell. All depreciation claimed (accelerated or not) is subject to recapture at sale. The Solution: Understand the full picture:

Depreciation Recapture

When you sell, depreciation is "recaptured" and taxed at up to 25% (higher than long-term capital gains rates). However:

You would pay recapture regardless of whether you did cost segregation
You got to use the money sooner (time value of money)
Your current marginal rate may be higher than 25%, so you still win

1031 Exchange

If you do a 1031 exchange into another property, depreciation recapture is deferred. You'll take a lower basis in the new property, but you've effectively kicked the can down the road.

Hold Forever Strategy

If you hold until death, your heirs receive a stepped-up basis and all that depreciation is effectively forgiven.

Bonus Mistake: Not Doing a Look-Back Study

Many investors think cost segregation only applies to newly acquired properties. In reality, if you've owned a property for years without a cost segregation study, you may be able to:

Conduct a look-back study for any prior year

File Form 3115 to change your accounting method

Claim all missed depreciation in a single year (no amended returns!)

This can result in massive one-time deductions, especially for properties owned during years with 100% or 80% bonus depreciation.

How to Get It Right

Cost segregation done correctly can save you substantial money while staying fully compliant with IRS rules. Here's your checklist:

[ ] Order study early (ideally before or immediately after closing)
[ ] Use a qualified, engineering-based provider
[ ] Include all assets: building, land improvements, and equipment
[ ] Coordinate implementation with your CPA
[ ] Consider your exit strategy and long-term tax planning
[ ] Evaluate look-back opportunities for existing properties

Don't let avoidable mistakes reduce your cost segregation benefits. Take the time to do it right, and you'll maximize your tax savings for years to come.

Avoid Costly Mistakes—Get It Right the First Time

Our platform guides you through cost segregation the right way. In minutes, you'll have a clear breakdown of your property's depreciable assets, with methodology your CPA can implement confidently.

Start Your Analysis →

No guesswork. No missed deductions. Just accurate, IRS-compliant cost segregation benefits for your property.