1031 Exchange in Tennessee: No Income Tax, Franchise and Excise Tax, FONCE

No Tennessee tax on the gain itself: the Hall tax is gone and nothing replaced it

Tennessee never taxed wages or capital gains, and the Hall income tax on interest and dividends was repealed for tax periods beginning January 1, 2021. An individual who sells a Nashville duplex or a Chattanooga warehouse owes federal tax on the gain and depreciation recapture and nothing to the Tennessee Department of Revenue, and a 1031 exchange defers the federal part.

There is no real estate withholding at a Tennessee closing for resident or nonresident sellers, and Tennessee does not follow deferred gain the way California does with Form FTB 3840. Once your replacement property is acquired, Tennessee has no further interest in the deferred gain, wherever that property sits.

Franchise and excise tax reaches the LLC or LP that holds the rental

The entity is where Tennessee's tax bites. Corporations, limited partnerships, limited liability companies and business trusts that are chartered, qualified or registered in Tennessee or doing business here must register for franchise and excise tax, and that includes an LLC whose only asset is one rental house.

The franchise tax is 0.25 percent of net worth with a $100 minimum that applies to every registered entity, active or inactive, and the excise tax is 6.5 percent of Tennessee taxable income built from the entity's net earnings for the year. Whether the gain a completed exchange defers federally also stays out of the excise base is a point to resolve with your CPA ahead of closing, because the entity files a return either way.

Public Chapter 950, signed May 10, 2024, removed the property measure from the franchise tax for tax years ending on or after January 1, 2024. Before that change the tax was computed on the greater of net worth or the book value of real and tangible property in Tennessee, which meant a property-heavy LLC with thin equity still paid on the building; now Schedule F net worth is the only base. The refund window for earlier years ran from May 15 to December 2, 2024 and has closed.

The FONCE exemption fits family-owned residential rentals and farms, not commercial buildings

A family-owned non-corporate entity is exempt from franchise and excise tax if at least 95 percent of its voting rights, capital interest or profits are owned by relatives (first cousins or closer, spouses and former spouses and their lineal descendants, or trusts and estates for them) and at least 66.67 percent of its activity is the production of passive investment income, or passive investment income combined with farming.

Passive investment income means royalties, rents from residential property or farm property, dividends, interest, annuities and gains on stock or securities. Residential property cannot have more than four units at any one location, and rent from commercial property is non-passive, so a family LLC holding a strip center cannot use FONCE while one holding two fourplexes and a farm can.

The exemption is claimed by application and renewed annually. If your entity has been FONCE-exempt and you exchange into a different kind of asset, rerun the test: replacement property that produces commercial rent can end the exemption in the year it arrives. Tennessee also exempts obligated member entities, LLCs or LPs whose members are fully liable for the entity's debts, which some owners use instead.

Realty transfer tax and mortgage tax at the register of deeds

Tennessee's recordation tax has two parts. The realty transfer tax is $0.37 per $100 of purchase price, paid by the grantee or transferee when the deed is recorded, and the mortgage tax is $0.115 per $100 of indebtedness above the first $2,000, paid by the borrower when a deed of trust is recorded. Both are collected by the county register of deeds and remitted to the Department of Revenue.

An exchange changes none of this. Your buyer pays transfer tax on your relinquished property, you pay it when you take a deed to Tennessee replacement property, and any new acquisition loan carries mortgage tax. A DST interest is not a recorded deed to you, so buying one triggers no Tennessee recordation tax; if the DST's property happens to be in Tennessee, the sponsor dealt with the tax when it bought.

Assessment at 25 or 40 percent, and a reappraisal cycle a sale does not reset

Tennessee assesses residential and farm property at 25 percent of appraised value and commercial and industrial property at 40 percent, so the same $1,000,000 building carries a $250,000 assessment as a fourplex and $400,000 as an office. Counties reappraise on four-, five- or six-year cycles, and between reappraisals values generally stay put apart from physical changes to the property.

A sale therefore does not by itself reset the appraised value to the price paid; the buyer inherits the current-cycle value until the county's next reappraisal. If you are selling land in the Greenbelt program (at least 15 acres in agricultural use, or qualifying forest or open space land), rollback taxes come due when the sale disqualifies the land, and the Comptroller's Greenbelt Handbook explains that the seller is liable unless a written contract shifts it, or the buyer declares in writing an intent to continue the use and then fails to apply within 90 days, in which case the buyer alone owes it.