Originally posted by
@Joseph S.:
Here's what I understand (but take it with a grain of salt since I'm not an attorney or CPA):
Tennessee doesn’t have a state income tax so if you own your properties personally you are only subject to federal income taxes.
However, anybody really interested in real estate needs to consider protecting their finances from liability with a corporate veil. Tennessee has both an excise tax and a franchise tax. The excise tax which effectively is an income tax, is a flat 6.5% tax on net earnings from doing business in the state. The franchise tax is based on the greater of a business’s net worth or book value of real and tangible property owned or used in Tennessee with a rate of 25 cents per $100, of the business’s net worth with a minimum tax of $100. These taxes can take a HUGE chunk out of your final cash flow. An annual report must also be filed - LLCs costs no less than $300; C Corporations cost $20 (they don’t recognize S Corporations), LLPs cost no less than $250.
Many states shield LLCs, LLPs, and S Corporations from these taxes. However TN only provides such an exemption to Sole Proprietorships and General Partnerships – both of which do not have a strong corporate veil (which is the main reason why you incorporate in the first place). You can see a breakdown of how each of these entities is treated with examples here: http://www.nolo.com/legal-encyclopedia/tennessee-state-income-tax.html.
Fortunately, it appears there are a couple exemptions that can allow you to get the benefits of a corporate veil without paying the taxes. The one I am personally considering is the FONCE (family owned non-corporate entity) exemption which waives both the excise and franchise taxes if at least 95% of the entity’s ownership must be directly held by family members AND substantially all (66.67%) of the activity of the entity is either the production of passive investment income or the combination of the production of passive investment income (which includes residential rental income) and farming. See the explanation here: https://www.tn.gov/revenue/article/fae-fonce-exemption.
However, in 2009 the TN legislature amended the FONCE exemption to no longer include rent from industrial and commercial property – so if you’re into commercial real estate investment (which includes property with more than 4 units) you’re paying the full bill. See details here: http://www.wallerlaw.com/News-Events/Bulletins/24893/Tennessee-Modifies-the-FONCE-Exception-to-the-Franchise-and-Excise-Taxes-and-the-Filing-Requirements-for-Many-Other-Exemptions. It may also be worth noting that the FONCE does have some critical reporting and application instructions so be sure to review this carefully with your CPA.
All that to say, you're pretty much screwed if you're into commercial (you're either paying huge taxes as an entity or huge insurance premiums to limit liability), but have a safe out if you're invested in residential with an LLC with a FONCE exemption.
If you're investing in TN from out of state your own state may have their own fees and taxes you'll need to consider.
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