EXPLAINED: "Real" cost segregation vs. DIY cost segregation

Julio GonzalezPro Member

Specialist · West Palm Beach, FL · Member since 2008 · 4k+ posts · 1k+ votes

3y

Great post! Thanks for sharing, @Michael Plaks !

561-253-6640

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Eric Williams

Accountant · Houston, TX · Member since 2023 · 147 posts · 41 votes

2y

1. Is DIY cost segregation allowed? The tax law does NOT define specific requirements or standards for cost segregation studies, and neither does the IRS.

Absolutely untrue. You can simply go to the Cost Seg Audit Technique Guide.

As for tax law, yeah the standard is if you deduct anything on that return, you have the obligation to prove it if challenged. Deductions are a matter of legislative grace and the taxpayer bears the burden of proof, both of production and persuasion. Welch v Helvering

So if you put forth that you can deduct things faster under 162, 167, 168, etc., those are definitely standards you may be held to.

Also keep in mind you may pay for a benefit you don't actually accelerate because it gets suspended. Remember that you HAVE to take the depreciation, even if you don't benefit. So you may just end up delaying ordinary deductions and increasing ordinary income with recapture under 1245.

This also means you may get tax deductions at a rate lower for deductions when you have less income, and higher rates charged on recapture in the year of disposal. Also your capital gain is lowered the more you bonus.

If you are going to accelerate you need to really consider how much personal property there, how long you're going to hold it, any offsets available, alternative transaction structures like installment sales or even delaying it a year.

Publication 5653 (6-2022) (irs.gov)

It lists four more including the ones below.

The detailed engineering cost estimate approach (or detailed estimate approach) is similar
to the detailed cost approach. The difference is that the detailed estimate approach
estimates costs, rather than using actual costs. This approach is used when cost records
are not available such as for an acquisition of used property. I

The detailed engineering approach from actual cost records, also called the “detailed cost
approach” or “direct cost method”, uses cost information from contemporaneous
construction and accounting records. In general, it is the most methodical and accurate
approach, relying on solid documentation of the construction costs and minimal cost
estimating. Construction documentation, such as construction drawings, specifications,
contracts, job reports, change orders, payment requests, and vendor and supplier invoices,
are used to determine unit costs. The use of actual cost records in this approach
contributes to the overall accuracy of cost allocations, although issues may still arise as to
the proper classification of specific assets.

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Michael PlaksPro Member

OP

Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes

2y

Quote from @Eric Williams:

1. Is DIY cost segregation allowed? The tax law does NOT define specific requirements or standards for cost segregation studies, and neither does the IRS.

Absolutely untrue. You can simply go to the Cost Seg Audit Technique Guide.

You point to ATG? Sure. First, ATG is not law but merely an administrative guidance. However, here is a quote from the ATG itself which confirms my statement.

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Henry ClarkPro Member

Developer · Member since 2020 · 4k+ posts · 4k+ votes

2y

@Eric Williams. What I love about BP is that all contributors can both be right and wrong. All can have different risk reward scenarios, all can have different perspectives. Just the turn of words “tax law” can mean a difference in perspective or emphasis.

But most importantly as an investor I get the bonus of several approaches and technical backgrounds. And I have the responsibility to do due diligence. Several posts I have made I have failed to include “check zoning”, but the reader must do their due diligence.

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Sean O'KeefePro Member

CPA | Accepting new clients | 50 States · Member since 2022 · 1k+ posts · 870 votes

2y

Quote from @Henry Clark:

@Eric Williams. What I love about BP is that all contributors can both be right and wrong. All can have different risk reward scenarios, all can have different perspectives. Just the turn of words “tax law” can mean a difference in perspective or emphasis.

But most importantly as an investor I get the bonus of several approaches and technical backgrounds. And I have the responsibility to do due diligence. Several posts I have made I have failed to include “check zoning”, but the reader must do their due diligence.

I could be wrong, but I think the purpose of this forum isn't for CPAs to fight and throw out IRS Pubs and Regs (although, these are helpful) to impress everyone.

It's to provide clarity on Real Estate Financial, Tax, & Legal to real estate investors who probably don't have a strong background in tax, legal or financial. If they did, they wouldn't be here asking questions : )

As a result, this means that CPAs, Lawyers, and Financial professionals should explain things in simple terms that are easy for people to understand (I'm not sure quoting pubs and regs directly screams simplicity, but including it as a reference is helpful for everyone).

[email protected]628-241-0888

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David M.

Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes

2y

@Eric Williams

Thanks for referencing the ATG. As a layman, I don't run into them, and usually need my cpa to reference one / send it to me to read to educate myself.

There are all sorts of "levels" here on BP. I know the Guide isn't law, but in my experience its not the law that is solely enforced, but also the derivative regulations, formal guidance documents, as well as case law history.

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Bonnie Griffin KaakePro Member

Real Estate Consultant · Denver, CO · Member since 2021 · 661 posts · 389 votes

2y

@Michael Plaks This is one of the better posts you have put up on BP. Good job!

[email protected]303-475-4459

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Sean GrahamBusiness Member

Investor , CPA · Detroit, MI · Member since 2016 · 582 posts · 248 votes

1y

Quote from @Michael Plaks:

When your property is relatively inexpensive, say $200k, and you want cost segregation applied to it - is it worth it to hire a cost segregation firm and pay their fee?

Before we explore this question, an important reminder: make sure that you can benefit from cost segregation, to begin with. I discussed this at length here: https://www.biggerpockets.com/forums/51/topics/1075919-five-...

Now, back to the "is it worth it?" Assume the cost segregation firm identifies $50k worth of quick depreciation in your $200k property. With the current 80% bonus depreciation, it translates into a $40k deduction and $10k in tax savings, give or take. The firm's fee will probably eat 1/4 to 1/3 of your savings. Does not sound too great, right?

In this situation a DIY cost segregation option sounds appealing. You only pay around $500, but you have to make your own estimates for everything inside your property and enter these numbers into their software. What software? There are at least two companies that offer this service via their websites: KBKG and DIYCostSeg. Easy to find them with Google.

Should you or should you not?

1. Is DIY cost segregation allowed? The tax law does NOT define specific requirements or standards for cost segregation studies, and neither does the IRS. The IRS expects your cost seg report to be "factually intensive", "supported by corroborating evidence" and performed by a "qualified individual.” So, the answer is: there is nothing that clearly prohibits DIY cost segregation reports.

2. Is DIY cost segregation reliable? Well, what is it based on? Your own estimates. Are they reliable? If you consider yourself a "qualified individual" to make such estimates - maybe. After all, you work in real estate, right? Just remember that all software, including cost segregation software, works on the GIGO principle: garbage in - garbage out.

3. Is DIY cost segregation audit-proof? First, let's define "audit-proof." If you think of audit-proof as avoiding an audit - then no. There is no way to prevent an IRS audit from happening, despite the hyped-up claims of some tax firms. You can minimize your chances, but the chance is never zero. In fact, using cost segregation results in an unusually high depreciation deduction, which IS an IRS audit flag. Cost segregation DOES make an IRS audit more likely.

The real question is: if you happen to get audited, will your cost segregation survive such an audit? With a "real" cost segregation study, it is signed by a licensed engineer who absolutely is a "qualified individual." I have not heard of the IRS challenging, much less overturning a professionally done cost segregation study.

Not so with DIY cost segregation. Here the IRS has a reason to challenge your credibility and the credibility of your self-produced numbers. Be prepared to defend it if the stuff hits the fan.

4. But they offer audit insurance! They do. And I highly recommend paying an extra $200 or so for it. However, it does not mean they will defend your numbers. What they will do if your DIY-ed cost segregation is audited is they will send you an engineer (you pay travel costs) to conduct a "real" cost segregation study and present it to the IRS instead of yours.

5. Then what's the reason to have a "real" study if it exists as a backup option anyway? Ahh. There is a critical one. An engineer sent by a cost segregation firm can find a lot MORE components to bonus-depreciate than you can estimate yourself. It's quite possible that they can find enough additional deductions to pay for the additional cost of their service and sometimes a lot more. The more expensive your property is - the more likely this to be the case.

Conclusion.

DIY is an option. Just like it is an option with almost anything. You have to make your personal decision, considering the time and effort it will take you to DIY it; the risk of it being done wrong, and the potential opportunities you might miss by not letting the pros handle it for you.

The more expensive your property is - the more reasons you have to hire professionals.

@Michael Plaks this post is great. There are so many details a professional firm will find vs. DIY. The tax benefit typically way more than pays for the cost of the study

Maven Cost Segregation Tax Advisors555 Reviews

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Austin L. Smith

Accountant · NV · Member since 2024 · 39 posts · 25 votes

1y

Hey,

Awesome post. In regards to the DIY software, it does make sense to get the insurance. In the event you underestimate the section 1245 assets, an audit would simply result in an positive adjustment for the tax liabillity. For a property that clearly has an abudance of section 1245 assets but is below 500k, using the DIY software would be a cost effective way to generate the study. While if there is few to no section 1245 assets, then the risk of overestimates with this application would increase. This seems to lead to the point of necessity for professional judgement and risk assesment.

I am more comfortable with the idea of the DIY software now.

Thank you for the information!

Austin L. Smith, CPA

1 Reply

Bernard ReiszPro Member

CPA delivering RE Tax Tools: 1031 Exchange, SDIRA, 401(k), Cost Seg · New York City, NY · Member since 2017 · 581 posts · 563 votes

1y

Being that there are a myriad of Cost Seg inputs and outputs - many of which are highlighted in @Michael Plaks post here and elsewhere - that benefit from your tax accountant's involvement, we always encourage investors to involve their tax pro in the Cost Seg process from the get-go. We find that the Cost Seg outcome is always enhanced, in every regard, with accountant involvement.

[email protected]

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Sagiv O.

Real Estate Investor · Austin, TX · Member since 2017 · 73 posts · 17 votes

8mo

@Michael Plaks - Excellent breakdown of the DIY vs. traditional cost seg dilemma. You're absolutely right that the traditional $2-6k fee structure can kill the ROI on smaller properties.

There's actually a third category that's emerged since you wrote this: automated engineering-based studies. They sit between DIY software (like KBKG) and full custom engineering firms. Think of them as productized cost seg - same IRS-defensible methodology and audit support as the big firms, but delivered through software with standardized processes.

For residential properties under $500k, this middle ground often makes the most sense. You get the audit protection and engineering rigor, but at price points ($500-600) where the ROI actually works. Room42 is one example - CPA-friendly reports, optional manual review, same methodology every time.

The key question isn't just "can I save on the study cost" but "will my CPA accept it and will it hold up if audited?" DIY tools are cheap but risky. Full studies are bulletproof but expensive. The newer options try to thread that needle for smaller deals.

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Account Closed

Investor · Member since 2026 · 2 posts · 0 votes

7mo

I have seen your a lot of your great discussion here, Michael. In my full understanding, what clicked for most investors was seeing the professional report not as a line-item cost, but as buying documented expertise for their own numbers.

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Account Closed

Investor · Hinton, WV · Member since 2026 · 10 posts · 5 votes

7mo

Great breakdown as always, Michael. The DIY vs. professional decision really comes down to whether you want a number or a defensible position. For my own properties, I chose the latter. I used cost-segregation guys because their engineered report gave my CPA the confidence to file without hesitation, and the additional 5-year assets they identified more than covered the fee difference.

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EXPLAINED: "Real" cost segregation vs. DIY cost segregation

EXPLAINED: "Real" cost segregation vs. DIY cost segregation

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