Cost Segregation Study in Tennessee

Tennessee has no individual income tax. The Hall tax on interest and dividends was fully repealed effective 2021, so an individual holding Tennessee rental property directly faces no state income tax on rents, on recapture, or on gain.

The complication is the franchise and excise tax, which reaches most LLCs, limited partnerships, and corporations doing business in Tennessee. And on that tax, Tennessee has quietly diverged from the federal rules in a way that gets worse each year. Tennessee stayed on the old TCJA bonus depreciation phase-down. It allows 20% bonus in 2026 and zero in 2027, while the federal rate is a permanent 100%.

How Tennessee Income Tax Interacts With Federal Strategy

Tennessee imposes no individual income tax. That covers wages, rental income, interest, dividends, and capital gains. For an individual owning property directly or through a disregarded single-member LLC that is not subject to franchise and excise tax, there is no Tennessee income tax layer at all.

The franchise and excise tax is a different matter. The excise tax is 6.5% of net earnings and the franchise tax is 0.25% of the greater of net worth or, historically, the value of real and tangible property in Tennessee, though the property measure was repealed in 2024. Together they apply to corporations, LLCs, limited partnerships, and other limited liability entities.

General partnerships and sole proprietorships are outside the franchise and excise tax. So are entities qualifying for specific exemptions, including certain family-owned non-corporate entities and residential and farming entities meeting statutory tests. Whether your Tennessee holding structure is inside or outside the F&E net is the first question to answer, because it determines whether any of the depreciation analysis below applies to you at all.

Tennessee Pass-Through Entity Tax

Tennessee has no pass-through entity tax and does not need one in the conventional sense. With no individual income tax, there is no individual-level state income tax to shift to the entity.

There is a related benefit that Tennessee owners often overlook. The franchise and excise tax is imposed on the entity, not on the owner, and it is deductible as an ordinary business expense on the federal return. It is not subject to the individual SALT cap and requires no election to obtain that treatment. Tennessee entities effectively receive the core PTET benefit automatically.

For owners with property in multiple states, the Tennessee position is a useful baseline. Income sourced to Tennessee carries no individual state tax and no SALT-capped deduction problem, which makes Tennessee-sourced income structurally more valuable per dollar than income sourced to a high-tax state, before any planning.

Tennessee Depreciation Conformity

This is where Tennessee has become a genuine problem for 2026 and beyond, and it is not widely understood.

The Tennessee Works Tax Act, Public Chapter 377 of 2023, coupled Tennessee to the federal bonus depreciation provisions of the Tax Cuts and Jobs Act for assets purchased on or after January 1, 2023. At the time this was a taxpayer-favorable change, because previously Tennessee disallowed bonus entirely for excise tax purposes.

But Tennessee coupled to the TCJA schedule, not to the current federal law. When the One Big Beautiful Bill Act restored 100% bonus depreciation permanently, Tennessee did not follow. The Tennessee Department of Revenue confirmed this in Notice #25-36, issued in December 2025, stating that Tennessee remains coupled to the TCJA bonus provisions.

The result is a widening gap. For excise tax purposes Tennessee allows the TCJA phase-down percentages: 40% for assets placed in service in 2025, 20% for 2026, and 0% for tax years 2027 and later, unless the legislature acts. Federally the rate is 100% in all of those years.

Cost Segregation Considerations Specific to Tennessee

Tennessee's divergence creates three planning consequences.

First, the size of the gap in 2026 is dramatic and it is easy to model wrong. On a $500,000 reclassification, federal bonus allows the full $500,000 immediately. Tennessee excise tax allows $100,000. The other $400,000 recovers over the MACRS lives. At the 6.5% excise rate the annual dollars are moderate, but any Tennessee F&E projection built off a federal-only cost segregation report will be materially overstated for 2026 and completely wrong for 2027.

Second, there is a placed-in-service timing decision available in 2026 that will not exist in 2027. Property placed in service during 2026 gets 20% Tennessee bonus. The same property placed in service in January 2027 gets zero under current law, absent legislation. For Tennessee F&E taxpayers with projects near completion in late 2026, accelerating placement in service into 2026 has a quantifiable Tennessee benefit on top of the ordinary federal timing benefit. This is one of the few genuine year-end deadlines on this list.

Third, entity structure determines whether any of this matters. An individual owning a Nashville or Chattanooga rental directly, or through a structure outside the franchise and excise tax net, is unaffected by the Tennessee conformity gap entirely and captures the full 100% federal bonus with no state consequence. The conformity problem is specific to F&E taxpayers. For Tennessee real estate investors this makes entity selection a first-order decision rather than an afterthought.

Nashville's short-term rental market and the Smoky Mountain corridor around Gatlinburg, Pigeon Forge, and Sevierville produce the highest reclassification percentages in the state, frequently 30% or more on furnished properties. Those are also the markets where owners are most likely to have used an LLC that falls inside the F&E net for liability reasons, which is exactly where the conformity gap bites. The two decisions should be made together.

Working With AE Tax Advisors in Tennessee

AE Tax Advisors works with real estate investors, business owners, and high-income professionals across Tennessee and all fifty states. We are a licensed CPA and IRS Enrolled Agent practice based in Billings, Montana, and we handle the engineering-based cost segregation study, the Tennessee conformity adjustments, the entity structuring, and the return preparation as one engagement rather than three vendors who do not talk to each other.

That matters more in Tennessee than it does in a state with simple conformity. A cost segregation provider who delivers a federal-only report leaves you and your preparer to work out the Tennessee treatment after the fact, which is where the errors happen. We model the federal and Tennessee outcome together before the study is commissioned, so you know what the number actually is on both returns before you spend anything.

Related reading: the complete guide to cost segregation, our cost segregation study service, short-term versus long-term rental tax treatment, lookback studies and Form 3115, and multi-state tax planning.

Tennessee tax rates, pass-through entity tax rules, and depreciation conformity provisions described on this page reflect law in effect as of August 2026 and are provided for general information only. State conformity changes frequently and often retroactively. Nothing here is tax advice for your situation, and no client relationship is created by reading it. Talk to us about your facts before acting.