Missing Land Allocation Is the Number 1 Cost Segregation Red Flag

James C. Peacock spent 38.5 years at the IRS as a General Engineer. He was among the first IRS engineers to examine cost segregation, contributed to the Cost Segregation Audit Techniques Guide from its first release in 2004 through its most recent update in February 2025, and trained roughly 200 new-hire IRS engineers before he retired in September 2025. I sat down with him for 90 minutes to ask what he actually looked at when a cost segregation study landed on his desk. The answer wasn't what most investors expect.

Before he ever looked at the 5-year property allocations, the 7-year classifications, or whether the RS Means codes were specific enough, he checked one thing. He checked whether the land was there.

Why Land Is Non-Depreciable — and Why That Makes It the First Check

Under IRC Section 168, depreciation only applies to property with a determinable useful life. Land doesn't wear out. You cannot take depreciation on it. Cost segregation is specifically the process of separating building components from the land and reclassifying them into shorter depreciation lives. That process only works if the land has already been carved out of the depreciable basis.

This sounds obvious. But James told me it's one of the most common problems he saw in studies.

"If a property is purchased for a million dollars and the study adds up to a million dollars, we go — where's the land?"

— James C. Peacock, former IRS Engineer SME

When the building components sum to the full purchase price, the land wasn't carved out. That means the depreciable basis includes value that should never have been depreciable. The IRS doesn't negotiate this. It's not a classification dispute. It's a mathematical correction. The examiner makes the adjustment, and the taxpayer loses the excess depreciation they took.

This is what "automatic adjustment" means in practice. There's no argument to have. Missing land is not a gray area. It is a black-letter error.

The High-Rise That Was Missing Its Entire Structure

James walked me through a specific example that illustrates how these problems compound. He reviewed a high-rise study where the 1245 property (personal property reclassified to 5-year or 7-year) looked reasonable on its face. The numbers made sense. The categories were plausible.

But when he got to the 1250 property (the structural elements of the building itself — the 39-year or 27.5-year property), something was wrong. There was no steel framework in the allocation. No concrete slabs. For a high-rise, those are among the largest cost components in the entire project.

"Tens of millions of dollars just gone. That was an automatic adjustment right there."

— James C. Peacock, former IRS Engineer SME

What happened in that study? The focus was entirely on finding 1245 property to accelerate. So much attention went to moving things to shorter lives that the structural 1250 property was treated as an afterthought. Steel and concrete didn't show up because nobody was looking for them on that side of the ledger.

James flagged this as a broader pattern. "We would get cost seg studies where there was so much emphasis on getting the 1245 property estimated that the 1250 property was an afterthought." The irony is that missing 1250 property creates the same problem as missing land — except instead of excluding non-depreciable value, you're excluding 39-year property. The basis still doesn't reconcile. And when an IRS engineer sees the study total doesn't match the purchase price, they start looking for what's missing.

How IRS Engineers Actually Verify Land Allocation

The first IDR (Information Document Request) in a cost segregation examination asks for the purchase agreement and the cost segregation study. The purchase agreement includes the purchase price. The study should show how that purchase price was split between depreciable property and non-depreciable land. If the methodology for that split isn't explained and supported, the next IDR will ask for it.

James made the economics of IDRs very clear: "The least amount of IDRs, the easier the audit goes." Every IDR generates a response cycle. Every unclear response generates another IDR. A study that documents its land allocation methodology cleanly and specifically can stop that cycle before it starts. A study that uses a vague reference to county assessor ratios invites the next question.

For land allocation specifically, IRS engineers want to understand:

• 1.What methodology was used to establish the land value (independent appraisal, county assessor, allocation in the purchase agreement, or some combination)
• 2.Whether that methodology is property-specific or a generic ratio applied mechanically
• 3.Whether the resulting land value is supported by documentation that would survive scrutiny if the IRS pulled the thread

Pro-rata alone is not accepted. Using a fixed 10% or 20% land percentage without property-specific support does not pass. The question is what supports that number, not just what the number is.

Independent Appraisal vs. County Assessor: What the IRS Prefers

There are several methods for establishing land value in a cost segregation study. Independent appraisal is the strongest. The IRS will not automatically reject a county assessor approach, but the assessor approach has a known weakness that experienced examiners understand.

County assessor values reflect assessed value, which is set for property tax purposes. Assessed value often departs significantly from actual market value, sometimes intentionally. This is especially true in states with Proposition 13-style assessment caps.

The California Proposition 13 Problem

California's Proposition 13, passed in 1978, caps property tax assessments. The assessed value of a property in California is generally locked at the purchase price from when it was last sold, plus a maximum 2% annual increase. A property that sold for $500,000 in 2005 might be assessed at $700,000 today even though its actual market value is $3.5 million.

When a cost segregation study uses the California county assessor's land-to-improvement ratio to allocate land, it may be using a ratio derived from a 2005 assessed value. That ratio has nothing to do with the property's current market value or the actual land value at the time of the recent purchase. An IRS engineer who knows California property tax law will immediately recognize this as unsupported.

Several other states have similar assessment limitations. Any state where assessed value is administratively capped or routinely diverges from market value creates the same problem. The county assessor ratio is not inherently wrong as a starting point, but it needs corroboration from market-based evidence, and an independent appraisal is the clean solution.

When the Adjustment Factor Is Too High

A related problem James flagged is the adjustment factor. Cost segregation studies use cost estimation methodologies — typically RS Means or similar construction cost databases — to estimate what the individual building components cost. Those estimates are then scaled to reconcile with the actual purchase price.

When the raw estimate is factored up substantially to match the purchase price, that scaling factor becomes a red flag. A 10x adjustment factor — where the raw RS Means estimate was multiplied by 10 to reach the depreciable basis — signals that something is missing from the estimate itself. Either land wasn't properly excluded, the scope of the work was underestimated, or the methodology wasn't property-specific. James put it directly: "There's usually something missing in the estimate if the factors are that bad."

High adjustment factors are one of the reasons RS Means specificity matters. James goes to the back of a study looking for 12-digit or 16-digit RS Means codes. A line item that says "RS Means mechanical" with no code attached is a reason for an IDR. Vague codes cannot be verified. Property-specific codes can. Square footage models (applying an average cost per square foot without property-specific analysis) are worse: they tell the IRS the engineer used averages and didn't actually look at the property.

LUQ: Large Unusual Questionable Items

IRS examination uses a framework called LUQ: Large Unusual Questionable items. These are allocations that look wrong based on the property type, use, or known cost patterns. Land allocation fits here when the carve-out is implausibly small for the location or property type. But LUQ applies across the entire study.

James gave me an example. A warehouse where 50% of the cost is allocated to HVAC. That's an LUQ. Standard warehouses have simple HVAC. 50% of cost in HVAC either means the warehouse is refrigerated (in which case the study should say so and document the equipment) or something is wrong with the allocation. The IRS doesn't publish percentage thresholds for what is or isn't acceptable. James explained why:

"The IRS deliberately never published percentage thresholds because as soon as we say X percent is acceptable, everyone's going to claim X minus 1 percent."

— James C. Peacock, former IRS Engineer SME

This is an important point for anyone evaluating their cost segregation study. There is no safe harbor percentage. A 15% 5-year allocation on a property where the typical range is 25-35% will not attract scrutiny simply because it's conservative. But a 40% 5-year allocation on a property where 15-20% is typical needs strong support behind it. The IRS won't reject it automatically, but the support has to be there.

For more on how IRS engineers evaluate studies in full, see our guide on what an IRS engineer looks for in a cost segregation study.

What "The Support, Not the Report" Actually Means for Land

Throughout our conversation, James kept returning to a mantra from his IRS career. A colleague's phrase that he said captured everything about how examiners think:

"It's the support, not the report."

— IRS engineer mantra, as shared by James C. Peacock

For land allocation, this means the number in the study isn't what the IRS is evaluating. They're evaluating the methodology and documentation that produced the number. A land allocation of $180,000 on a $1,200,000 purchase is 15%. Whether that's defensible depends on what supports it. An independent appraisal that documents local land values, comparable land sales, and a market-based analysis produces defensible support. A line in the report that says "land allocated per county assessor ratio of 15%" produces a question.

The IRS can't disprove a well-supported appraisal. They can absolutely question a ratio that was pulled from a county website.

Practical Steps for Investors and CPAs

If you're evaluating a cost segregation study or planning to commission one, land allocation is the first question to ask about. Here's what to look for:

How This Fits into the Broader Audit Picture

Land allocation is the first check, not the only check. After confirming land was excluded, IRS engineers move through the rest of the study looking for the issues James catalogued across 38 years of examinations: vague RS Means codes, HVAC allocations that don't match the property's use, 1245 property claims that fail the White Coat test (property must be movable and in fact moved, not just theoretically removable), kitchen cabinets and similar items that Amerisouth v. Commissioner (2012) placed in 1250 property unless you can prove they were actually removed and reused.

But land allocation is the one place where the error produces an automatic adjustment. The others require analysis. Missing land does not.

For context on what the overall audit process looks like, see our walkthrough of cost segregation audit risk and how studies get examined. The broader IRS scrutiny picture matters too, but land allocation is where it starts.

The Takeaway

The cost seg industry spends most of its energy on 5-year property, bonus depreciation percentages, and total savings estimates. Those matter. But a study that gets the 5-year allocation right and the land allocation wrong is still a problem, and it's a problem the IRS finds immediately.

Before you ask your provider what percentage of the building they're going to reclassify, ask them how they established land value. Ask what methodology they used. Ask whether that methodology will hold up if someone looks at it. The answer to those questions tells you more about the quality of the study than any savings estimate does.

The number is not the support. The support is the support.