"Cost Segregation Is a Scam" — Is TikTok Right?
If you've been on TikTok, YouTube, or Reddit in the last year, you've seen the videos:
- "Cost segregation is a TRAP — here's why you'll regret it"
- "Your CPA is scamming you with cost segregation"
- "I did cost segregation and now I owe MORE in taxes"
- "The depreciation recapture nobody warns you about"
These videos get millions of views. And they're not entirely wrong.
Cost segregation is not a scam. But it IS a bad idea for a lot of people who are being sold it anyway.
After delivering 1,000+ cost segregation studies, we've also told hundreds of investors not to do it. This article explains when we say no — and why the internet's loudest critics are half right.
Author's note (Sam Young, EA): I run a cost segregation company. I have every financial incentive to tell you cost segregation is always amazing. But here's the truth: it's not. And the investors who get burned are usually the ones who were sold a study by someone who didn't care whether it actually made sense for their situation. This guide is the honest version.
The 7 Situations Where Cost Segregation Is a Bad Idea
1. You Can't Actually Use the Deductions (The Passive Activity Trap)
This is the #1 reason cost segregation fails for investors — and almost nobody talks about it.
Under IRC section 469, rental income is classified as "passive activity" for most investors. That means your cost segregation deductions can only offset passive income — not your W-2 salary, not your business income, not your investment returns.
If you're a W-2 earner making $300K with one rental property generating $15K/year in net rental income, and cost segregation creates $150K in paper losses... you can only use $15K this year. The other $135K sits in a "suspended loss" bucket, waiting for future passive income or the eventual sale of the property.
You didn't save $52,500 in taxes. You saved $5,250. The rest is theoretical — locked away behind passive activity rules that your cost seg salesperson conveniently forgot to mention.
| Your Situation | Cost Seg Deduction | Usable This Year | Suspended (Unusable) |
|---|---|---|---|
| $300K W-2, one rental, no REPS, no STR | $150,000 | $15,000 | $135,000 |
| $300K W-2 with REPS (spouse qualifies) | $150,000 | $150,000 | $0 |
| $300K W-2 with STR (under 7-day avg stay) | $150,000 | $150,000 | $0 |
| Full-time investor with $80K passive income | $150,000 | $80,000 | $70,000 |
The exceptions that make it work:
- Real Estate Professional Status (REPS) under IRC section 469(c)(7) — requires 750+ hours/year AND more than 50% of your working time in real estate
- Short-term rental loophole — average guest stay under 7 days + material participation (roughly 100+ hours/year)
If you don't qualify for either exception, cost segregation may generate impressive-looking numbers that you can't actually use. The deductions aren't lost forever — they'll offset income when you sell — but the time value benefit the industry advertises may be a fraction of what you were told.
Read more: Cost Segregation for W-2 Earners explains exactly how to unlock these deductions.
2. You're Selling Within 18 Months (The Recapture Wrecking Ball)
Cost segregation accelerates depreciation into year one. When you sell, the IRS "recaptures" that depreciation and taxes it:
- Section 1250 recapture (real property): taxed at up to 25%
- Section 1245 recapture (personal property — the stuff cost seg reclassifies): taxed as ordinary income at up to 37%
If you sell quickly, you get the deduction and the recapture tax in rapid succession. The time-value benefit — the whole reason cost segregation works — barely has time to compound.
| Hold Period | Tax Savings (Year 1) | Recapture Tax (at Sale) | Net Benefit (After Investing Savings at 7%) |
|---|---|---|---|
| 6 months | $52,500 | ~$45,000 | ~$9,300 |
| 1 year | $52,500 | ~$45,000 | ~$11,200 |
| 3 years | $52,500 | ~$45,000 | ~$19,800 |
| 5 years | $52,500 | ~$45,000 | ~$28,600 |
| 10 years | $52,500 | ~$45,000 | ~$58,300 |
| 1031 exchange | $52,500 | $0 (deferred) | $52,500+ |
Assumes $150K reclassified at 35% tax bracket, recapture at blended ~30% effective rate.
At 6 months, cost segregation barely breaks even after recapture. The study fee ($500–$5,000+) might eat the remaining benefit entirely.
The rule of thumb: If you're planning to sell within 18 months and NOT doing a 1031 exchange (IRC section 1031), cost segregation is likely a net negative.
3. Your Property Is Too Small (The Study Fee Eats the Savings)
Traditional cost segregation firms charge $5,000–$15,000+ for a standard study. If your property has $200K in depreciable basis and the study reclassifies 28% ($56K), your Year-1 tax savings at a 35% rate is ~$19,600.
Sounds good — until the $8,000 study fee takes it down to $11,600 net.
Now factor in depreciation recapture when you sell. The actual lifetime benefit might be $6,000–$8,000 — on a study that cost $8,000.
| Depreciable Basis | Traditional Study Cost | Year-1 Tax Savings | Net After Study Fee | Verdict |
|---|---|---|---|---|
| $100K | $3,000–$5,000 | ~$9,800 | $4,800–$6,800 | Marginal — be cautious |
| $200K | $5,000–$8,000 | ~$19,600 | $11,600–$14,600 | OK but thin |
| $500K | $5,000–$10,000 | ~$49,000 | $39,000–$44,000 | Strong |
| $1M+ | $6,000–$15,000 | ~$98,000+ | $83,000–$92,000+ | No-brainer |
This is exactly why we built Overline with studies starting at $499. At traditional pricing, many smaller properties don't justify the study. At our pricing, the math changes — a $300K property with a $1,500 study fee is a clear winner.
But if someone is quoting you $8,000 for a study on a $250K duplex, you should probably say no.
4. You're in a Low Tax Bracket (The Deduction Is Worth Less)
Cost segregation creates deductions, not credits. The value depends entirely on your marginal tax rate:
| Tax Bracket | Value of $100K Deduction | Is Cost Seg Worth It? |
|---|---|---|
| 37% | $37,000 | Almost always |
| 35% | $35,000 | Almost always |
| 32% | $32,000 | Usually yes |
| 24% | $24,000 | Evaluate carefully |
| 22% | $22,000 | Often marginal |
| 12% | $12,000 | Probably not |
| 0% (tax-exempt) | $0 | Definitely not |
If you're in the 12% bracket earning $45K/year with a small rental, cost segregation saves you roughly $12,000 per $100K reclassified. After study fees and future recapture, the net benefit is thin. You might be better off waiting for a higher-income year.
5. The Study Is Garbage (DIY and Non-Engineered Reports)
The biggest legitimate complaint about cost segregation online isn't about the strategy — it's about bad providers.
A BiggerPockets thread titled "Caution story: Cost segregation done WRONG" describes an investor whose "study" was rejected by their CPA because it lacked engineering methodology, had no site-specific analysis, and used generic template allocations.
Red flags of a bad study:
- No named engineer on the report
- No property inspection or photos
- Reclassification percentages identical across different property types
- Price suspiciously low (under $300) with "full study" claims
- No reference to IRS Audit Techniques Guide methodology
- Template-based report with generic allocations
The IRS Cost Segregation Audit Techniques Guide identifies 13 principal elements of a quality study. If your provider can't explain how they address each one, walk away.
The IRS imposes negligence penalties of up to 20% on underpayments resulting from poor cost segregation studies (IRC section 6662). A bad study doesn't just waste your money — it creates audit risk that a legitimate study wouldn't.
6. You Don't Plan for Recapture (The Tax Bill Nobody Mentioned)
This is the complaint driving most of the viral TikTok content. An investor accelerates $200K in depreciation, saves $70K in taxes, sells three years later... and owes $50K+ in recapture taxes they didn't expect.
Depreciation recapture isn't a flaw. It's a feature that requires planning.
Under IRC section 1245, personal property (the assets cost segregation reclassifies) faces recapture at ordinary income rates — up to 37%. Under IRC section 1250, real property recapture is capped at 25%.
The math still favors cost segregation on holds of 3+ years because of time value — but only if you knew recapture was coming and planned for it:
- 1031 exchange (IRC section 1031): Defers ALL recapture. This is why sophisticated investors almost never do outright sales.
- Installment sale (IRC section 453): Spreads recapture over multiple years. Note: IRC section 453(i) requires recapture income to be recognized in the year of sale.
- Hold until death (IRC section 1014): Stepped-up basis eliminates all recapture permanently.
The problem isn't recapture itself. The problem is providers who sell cost segregation without mentioning recapture, exit planning, or the critical role of entity structure.
Read our full guide on why tax strategies fail at exit.
7. Your Entity Structure Is Wrong (Structural Risk Outweighs Tax Savings)
Saving $60K in taxes while exposing $2M in equity to a single lawsuit is not optimization. It's a net negative.
If your properties are held in one LLC, or your operating activities and holdings are commingled in the same entity, cost segregation solves one problem (taxes) while ignoring a bigger one (liability exposure).
We've written extensively about this:
- Why investors lose everything from structure failure
- Cost segregation without structure is fake optimization
- The most expensive mistake: entity reuse
Cost segregation should never happen in a vacuum. It should be part of a comprehensive approach that includes entity isolation, insurance alignment, and exit planning.
What the TikTok Critics Get Right
The viral videos making the rounds aren't completely wrong. Here's what they correctly identify:
1. Many providers oversell the strategy. The cost segregation industry is full of firms that will sell a study to anyone with a pulse, regardless of whether it makes sense. Commission-based sales teams don't get paid for saying "this isn't right for you."
2. Passive activity rules are real. A shocking number of "cost segregation saved me $100K!" claims are from investors who can't actually use the deductions against their W-2 income. The tax benefit exists on paper but not in their bank account.
3. Recapture is real and rarely discussed upfront. Accelerated depreciation is a loan from the IRS, not a gift. It must be repaid at sale — unless you plan around it.
4. DIY and cheap studies are dangerous. The explosion of "cost segregation for $299!" services online has flooded the market with non-engineered reports that won't survive IRS scrutiny.
5. Not every property is a good candidate. Small properties, low-basis properties, properties in low tax brackets, and short-hold properties often don't justify the strategy.
What the TikTok Critics Get Wrong
1. Cost segregation isn't a scam — bad execution is. The IRS literally published a 120+ page Audit Techniques Guide endorsing the methodology. Tax Court cases dating to Whiteco Industries v. Commissioner (65 T.C. 664, 1975) and Hospital Corporation of America v. Commissioner (109 T.C. 21, 1997) have affirmed the approach for decades. The strategy is legitimate. The question is whether it's right for YOUR situation.
2. Suspended losses aren't "lost." They carry forward and are released when you sell the property or generate passive income. The deductions are deferred, not destroyed.
3. Recapture doesn't eliminate the benefit — it reduces it. On holds of 3+ years, the time value of Year-1 tax savings almost always exceeds the recapture cost. And 1031 exchanges defer recapture entirely.
4. The math has changed dramatically. With 100% bonus depreciation reinstated permanently and providers like Overline offering studies starting at $499, the threshold for "worth it" is much lower than what most critics assume.
The Honest Decision Framework
Use this to determine whether cost segregation is right for you:
DO cost segregation if:
- Depreciable basis above $50K (with Overline's low cost and engineering-based approach)
- Combined tax bracket above 30%
- Planning to hold 3+ years (or 1031 exchange at exit)
- You qualify for REPS or STR loophole (if W-2 earner)
- You're using a qualified engineering-based provider
- Your entity structure is sound
DON'T do cost segregation if:
- You can't use the deductions (passive activity trap with no REPS/STR path)
- You're selling within 18 months without a 1031
- Depreciable basis is under $200K and study fees are $5,000+
- You're in the 12% or lower tax bracket
- You're considering a DIY or non-engineered study
- Your entity structure hasn't been addressed
EVALUATE CAREFULLY if:
- Depreciable basis is $20K–$50K
- Hold period is 18 months to 3 years
- Tax bracket is 22%–28%
- You have passive activity limitations but expect future passive income
Not sure where you fall? Run the free calculator for a property-specific estimate in 60 seconds.
How Overline Is Different
We don't sell cost segregation to everyone. We build tools that help you figure out if it makes sense before you spend a dollar:
- Free calculator — See your estimated savings instantly, based on real data from 1,000+ completed studies
- Honest assessments — We'll tell you if cost segregation doesn't make sense for your property. We'd rather build trust than sell a study you don't need.
- Complete optimization — We integrate tax savings with insurance alignment, entity structuring, and exit planning
- Transparent pricing — Studies starting at $499, lowering the threshold where cost seg makes economic sense
The cost segregation industry has a trust problem. We're trying to fix it by being the provider that tells you the truth — even when the truth is "don't do it."
Frequently Asked Questions
Q: Is cost segregation a scam? A: No. Cost segregation is an IRS-endorsed tax strategy with decades of Tax Court precedent. The IRS published a detailed Cost Segregation Audit Techniques Guide that auditors use as the standard for evaluating studies. What IS problematic: unqualified providers selling studies to investors who can't benefit, DIY approaches without engineering methodology, and firms that never mention depreciation recapture or passive activity limitations.
Q: Why do so many TikTok creators say cost segregation is a bad idea? A: Because they're often describing real problems — passive activity traps, unexpected recapture taxes, and predatory providers. These are legitimate issues. But the conclusion that cost segregation itself is bad confuses poor execution with a flawed strategy. For the right investor with the right property and the right provider, cost segregation generates 15x-50x+ ROI.
Q: I did cost segregation and now I have suspended losses I can't use. What do I do? A: Your suspended passive losses aren't lost — they carry forward under IRC section 469. You can use them against future passive income, or they'll be fully released when you sell the property. To unlock them now, evaluate whether you qualify for Real Estate Professional Status or the STR loophole. You may also be able to generate passive income through other rental properties or passive investments.
Q: How do I know if my cost segregation provider is qualified? A: Ask for a sample report, confirm they use engineering-based methodology (not template-based), verify they follow the IRS Audit Techniques Guide's 13 principal elements, and check that a named engineer signs the study. If the price seems too low for legitimate engineering work, it probably is. Read our full guide on cost segregation audit risk.
Q: My CPA says cost segregation is too aggressive. Who's right? A: It depends on what they mean. If they're saying "cost segregation creates audit risk" — they're wrong. The IRS explicitly endorses it. If they're saying "your specific situation doesn't benefit from cost segregation because of passive activity limits and a short hold period" — they might be right. The key is whether their objection is specific to your facts or a general aversion. See why your CPA didn't tell you about cost segregation.
Q: Can I still benefit from cost segregation if I have passive activity limitations? A: Yes, but the benefit is deferred. Your deductions accumulate as suspended losses and are released when you sell or generate passive income. The year-one headline number won't match your actual year-one tax savings. This doesn't mean cost segregation is worthless — it means the ROI timeline is longer than advertised. Use our decision framework to model your specific situation.
Continue Reading
Explore more guides from our library:
- Is Cost Segregation Worth It? — The complete decision framework
- Cost Segregation Scams vs Legitimate Studies — How to tell the difference between real and fake studies
- How to Choose a Cost Segregation Provider — The 10-point evaluation checklist
- Cost Segregation for W-2 Earners — How to unlock deductions with REPS or STR
- Cost Segregation Audit Risk — What actually triggers IRS scrutiny
- Why Tax Strategies Fail at Exit — The recapture planning most investors skip
- How Much Does Cost Segregation Save? — Real data from 1,000+ studies
Disclaimer: This content is for informational purposes only and does not constitute legal, tax, or financial advice. Tax strategies depend on your individual circumstances, income level, property details, and applicable tax law. The passive activity rules, depreciation recapture provisions, and other tax concepts discussed are complex and fact-specific. Consult qualified tax and legal professionals regarding your specific situation.