Caution story: Cost segregation done WRONG

[Michael Plaks]

I have written before about the pitfalls of cost segregation, for example here: https://www.biggerpockets.com/forums/51/topics/831924-beware... and here: https://www.biggerpockets.com/forums/51/topics/1075919-five-...

While cost segregation is an excellent and powerful strategy when used correctly and under the right circumstances, it is certainly not some master key that unlocks all doors all the time. And you need a trustworthy cost segregation provider.

With permission from my client, I am sharing a story how a very well known cost segregation provider recently destroyed that trust.

My client bought a multifamily property and did extensive renovations to it. A cost segregation study was done and looked just fine. As I was working on their taxes, I noticed that cost segregation was based on $180k worth of renovations while the total rehab cost was $310k. Naturally, we asked the cost segregation company to adjust their report. And they did.

And boy, did they adjust! Before looking at the screenshot below, ask yourself: if you add another $130k of rehab costs, what do you expect to happen to your numbers segregated by category? Go down? Go up? Stay the same? 

If you struggled to answer my question, let's draw an analogy. You are having a dinner with your family. Your waiter brings you a check for $200 that includes:
- $50 for appetizers
- $100 for main courses
- $50 for drinks

Then she realizes - oops, sorry, I did not include part of your order, let me bring you a revised check. And she returns with a $300 check which is broken out ("cost-segregated") like this:
- $30 for appetizers
- $150 for main courses
- $50 for drinks
- $70 for desserts

Main courses went up, is it possible? Sure, she missed some the first time. Drinks stayed the same, is it possible? Of course. Desserts were not on the original check, is it possible? Clearly, she missed them initially. But how did appetizers go from $50 on the first check down to just $30 on the second one? I mean, you might not mind this sudden discount, but would not you get suspicious about the rest of her numbers now?

Now let's look at the before-and-after cost segregation results:

- moldings went down from $17k to $4k
- $20k security system disappeared altogether
- specialty plumbing dropped from $19k to $11k
and you can review the rest of this side-by-side comparison yourself.

Unlike my restaurant analogy, reduced or eliminated numbers on cost segregation are not only suspicious but they are outright detrimental to the investor. Yes, I understand that they sent a different engineer to survey the property the second time. But they both worked for the same company, were supposed to use the same methodology and certainly had access to their own prior results for the very same property.

If we did not need to adjust the total rehab costs, we would have only had the first report. And we would have never doubted its accuracy. But now there is no doubt: cost segregation results produced by this nationally reputable company are at best sloppy and at worst totally unreliable.

Your Honor, I rest my case.