Episode Overview

Podcast: Tax Smart Real Estate Investors Podcast
Episode: 356. The Missing Step in Cost Segregation Putting Real Estate Investors at Audit Risk
Date: December 2, 2025
Host: Hall CPA team, featuring Justin Shore and Nathan Sosa
Theme:
This episode dives into recent trends and rising risks concerning cost segregation (cost seg) studies for real estate investors—especially those relying on “software-only” solutions. The hosts share real audit stories, detail what IRS examiners scrutinize, and explain why on-site, detail-rich cost segs are now more defensible than ever. The episode also highlights new IRS audit technique guide updates and actionable tax planning opportunities that may save investors thousands (and headaches).

Key Discussion Points & Insights

1. Recent Audit Trends in Cost Segregation Studies

• IRS Confusion and Increased Scrutiny
  • Auditors often lack familiarity with cost seg studies, leading to many initial questions and requests for support ([02:07]).
  • Examiners’ experience level varies; sometimes only a depreciation report is required, other times the full study is scrutinized.
  • Material Participation Logs are always requested—regardless of whether the audit is cost seg-related ([03:10]).

Nathan Sosa [03:10]:
“One thing that I definitely have seen is…a lot more attacks on the five year property. Right. So 1245 property, we’ve seen a significant increase... IRS is kind of starting to say that they think … some assets are more structural and should be classified as 27.5-year.”

2. Required Documentation: The Critical Role of Photos and Detail

• Why Photos Matter
  • IRS auditors now frequently request photos of assets to confirm cost seg allocations, especially when a property has been sold or is remote ([04:43]).
  • Photos validate classifications (e.g., five-year vs. 27.5-year property), making file retention essential.

Justin Shore [04:43]:
“The requests I've received...they want to see pictures...It was tremendously helpful to have that extra amount of detail.”

3. Software-Based Cost Segregation Studies: Why They're Becoming Riskier

• Absence of Physical Evidence Increases Audit Risk
  • Software-only studies do not include site visits or photos, making them difficult to defend ([06:50]).
  • If the IRS challenges unsupported deductions, investors may face disallowed depreciation and potentially back taxes, penalties, and interest.

Nathan Sosa [07:04]:
“You might have a lot of disallowed deductions that you’re not expecting...software studies are becoming a lot riskier.”

• Audit Technique Guide (ATG) Updates
  • The IRS revised its cost segregation ATG in February 2025, explicitly recommending field inspections for “all quality studies” ([09:30]).
  • While not strictly required, lack of site visits/photo evidence triggers higher scrutiny.

Justin Shore [09:30]:
“The wording...says a field inspection is recommended for, quote, unquote, all quality studies...they’re telling their examiners, ‘let’s put [software studies] under higher scrutiny.’”

4. Ambiguity in IRS Rules & Impact on Study Quality

• No “Bright Line” Standard
  • The IRS does not publish a strict methodology or requirement list for cost segs; as a result, approaches and results vary by professional ([11:35], [14:15]).
  • The best defense remains a thorough, well-documented, site-based study.

Host [14:15]:
“There’s ambiguity around these rules…these software studies…are leading to an increased chance of risk…but...also more conservative because there’s risk reduction too.”

5. Engineering (On-Site) Studies: Safer, More Lucrative, Better Planning

• More Defensible & Often More Lucrative

  • Engineering/site-visit studies provide richer documentation, generally capture more depreciation, and hold up better under IRS scrutiny ([11:42], [14:58]).

• Tax Planning Flexibility

  • Detailed studies enable nuanced planning—like selectively applying bonus depreciation or making state-specific deductions ([15:57]).
  • Clients should use modeling to determine the best timing and methods for maximizing deductions and minimizing future recapture risk.

Justin Shore [15:57]:
“There may be instances where yes, the cost seg study makes sense, but do we want to apply the whole study in the same way on your tax return?...There are options for breaking out the details…making different elections.”

• Irrevocable Decisions: Proceed with Caution
  • Certain tax elections (e.g., opting out of bonus depreciation) are irreversible, so must be made with full planning and professional input ([19:58]).

Host [19:58]:
“They had elected out of bonus depreciation on all their properties…led to tens of thousands of dollars in missed tax savings.”

Notable Quotes & Memorable Moments

• On Rising Audit Challenges:
  “We’ve really seen this year especially a lot more attacks on the five year property...a pretty large increased tick on that part.”
  – Nathan Sosa [03:10]

• On the Value of Photos:
  “...they want to see pictures like of the assets in a lot of cases...that has helped on the studies that my clients have had where they did include pictures…”
  – Justin Shore [04:43]

• On Software Study Risk:
  “If you’ve done a bunch of software studies, it could wind up being painful. This is like literally this year that we’re starting to see this type of stuff.”
  – Nathan Sosa [07:04]

• On the Audit Technique Guide:
  “It’s pretty much like their field manual, instructing examiners on, like, what types of questions to ask, how to scrutinize…a field inspection is recommended for, quote, unquote, all quality studies.”
  – Justin Shore [09:30]

• On the Need for Strategic Planning: “That’s why we highly recommend that you work with a team of advisors like our tax advisors here at Hall CPA...the main point being...even things all the way down to which state...it can make a difference…”
  – Justin Shore [15:57]

Timed Key Segments

| Timestamp | Topic/Segment | |-----------|---------------| | 02:07 | Initial IRS audit confusion; material participation logs always requested | | 03:10 | Increased attacks on five-year (1245) property classifications | | 04:43 | IRS starting to request photo documentation of asset types | | 06:50 | Host asks about impact on software cost segregation studies | | 07:04 | Recent, sharp increase in audit scrutiny of software studies | | 09:30 | Discussion of the February 2025 Audit Technique Guide update | | 11:35 | Future outlook for software studies; ambiguity around methodology | | 15:57 | Additional planning opportunities from on-site studies; tax election nuances | | 19:58 | Real-world error: missed savings from improperly electing out of bonus depreciation |

Actionable Takeaways

• Photograph Everything: Retain photo evidence of relevant assets for all cost seg studies—especially if you sell the property later.
• Think Twice Before Choosing Software-Only Studies: The IRS is now scrutinizing these harder; site-based studies are safer and more lucrative.
• Stay Current with IRS Guidance: Be aware of the latest ATG (Feb 2025)—recommend site visits for “all quality studies.”
• Work with Pros: Engage a knowledgeable CPA and cost seg team for proper tax planning, election strategy, and audit defense.
• Plan Your Deductions Intelligently: One size does not fit all—evaluate what, when, and how to take bonus depreciation or Section 179 based on your portfolio, property specifics, and goals.

What’s Next

• Next Week: The team will be joined by Edward, Director of Cost Segregation, for a deep dive into the cost seg process and site visit best practices.
• Free Resource: Download the Year-End Tax Planning Checklist (link in show notes).

This episode is a must-listen for real estate investors using cost segregation studies. The takeaways could save thousands—not only in taxes, but also in audit defense costs.