The 32-year-old lost 7-6 (10-8) 7-5 to the world number 73 in a rain-delayed match at the state's Wake Forest University.
Murray had an operation on his hip seven months ago in a bid to prolong his career and after making a return to doubles earlier this summer, played his first singles match since undergoing surgery at the Western and Southern Open in Cincinnati last week, where he lost 6-4 6-4 to Richard Gasquet.
Hundreds braved the weather and waited for five hours as rain and thunder and lightning delayed the start to watch the former world number one, and while there were some glimpses of form from Murray, who had accepted a wildcard entry to the ATP 250 event, Tennessee native Sandgren proved too strong an opponent.
Murray struggled after losing the first set, being broken in the opening game of the second set and trailing 3-0.
He broke back twice to level the second set at 5-5, but hit a forehand into the net in the 11th game to hand the American the win.
Speaking after his Winston-Salem exit, Murray said: “I'm quite aware of where I'm at just now and what my level is.
"It's competitive at this level but it needs to be better - maybe I need play a level down to get some matches and build my game up a little bit before I start playing on the Tour again."
The two-time Wimbledon winner was upbeat as he assessed his movement, adding: "Some things were a bit better today, I think.
"I was hitting the ball a bit cleaner than I did in Cincinnati. I feel like I moved fairly well to some drop shots, which maybe last week I wasn't running to.
“So there's some good things in there but also some stuff I would like to do better. Physically, [I feel] OK considering, no pain, no discomfort. Just a little bit more tired than usual."
Murray was considering entering the doubles competition at the US Open at New York's Flushing Meadow, but eventually confirmed he would not play in the format as he focuses on rekindling his singles career.
He could now take part in the Murray Trophy - a new addition to the calendar, named after the Scot and his brother Jamie. It runs in Glasgow between September 16 and 22, a week before Murray is due in Asia to resume his ATP Tour schedule.