Cost Segregation Study in Tennessee for Airbnb and Short-Term Rental Investors

Tennessee has no state income tax on individuals. Wages and salaries have never been taxed at the state level, and the Hall tax — the state's narrow tax on interest and dividend income — was phased down from 6% in 2015 to 0% and fully repealed effective January 1, 2021. For a Tennessee investor who owns a rental property directly, or through a structure not subject to the state's separate business tax, this means there is no state income tax base at all against which depreciation rules could diverge from the federal return. The full benefit of a cost segregation study's federal deduction flows through untouched.

The wrinkle: many investors hold rental property inside an LLC for liability protection, and LLCs (along with corporations) doing business in Tennessee are generally subject to the state's franchise and excise (F&E) tax — a 6.5% excise tax on net earnings plus a franchise tax based on the entity's net worth — unless the entity qualifies for an exemption such as the family-owned non-corporate entity (FONCE) exemption (broadly, at least 95% family ownership combined with substantially passive or farming income). (Tennessee previously allowed an alternative franchise tax base measured by the book value of in-state real and tangible property, but the General Assembly repealed that property measure for tax years ending on or after January 1, 2024, so net worth is now the sole franchise tax base.) For LLCs and corporations that owe F&E tax, Tennessee has not adopted the federal One Big Beautiful Bill Act's permanent 100% bonus depreciation. Per Tennessee Department of Revenue Notice #25-36, the state's F&E tax remains statically coupled to the old, pre-OBBBA phase-down schedule: 40% bonus depreciation for property placed in service in 2025, 20% in 2026, and 0% for 2027 and later, unless the General Assembly acts to update conformity. That does not eliminate the deduction — it defers part of it for F&E purposes, recovered through ordinary depreciation over time — but it is a real difference from the federal return that entity owners should plan around.

Beyond the income-tax picture, Tennessee's average effective property tax rate is roughly 0.5%, among the lowest in the country, which keeps annual carrying costs modest relative to many other states. And the underlying real estate itself supports the strategy: Sevier County's cabin corridor — Gatlinburg, Pigeon Forge, Sevierville, and Wears Valley — sits at the doorstep of Great Smoky Mountains National Park, the most-visited national park in the United States, and is one of the largest concentrations of short-term-rental cabins anywhere in the country. Nashville, Chattanooga, and Memphis add substantial long-term and mid-term rental markets, though short-term-rental permitting rules vary by city and county and should always be confirmed locally before purchase.

Under standard depreciation rules, a residential rental building is written off over 27.5 years and a commercial building over 39 years, straight-line. A cost segregation study is an engineering-based analysis of the property that identifies components which the tax code allows to be depreciated far faster — carpeting, cabinetry, certain appliances, specialty electrical and plumbing runs, decking, and land improvements like driveways, fencing, and landscaping — and reclassifies them into 5-, 7-, and 15-year property.

That reclassification matters because of the One Big Beautiful Bill Act (OBBBA), signed July 4, 2025, which permanently restored 100% bonus depreciation for qualifying property acquired and placed in service after January 19, 2025. Property in the 5-, 7-, and 15-year classes generally qualifies for bonus depreciation, meaning the full cost of those components can be deducted in the year the property is placed in service, rather than recovered gradually over decades. The result is a much larger first-year deduction than the building alone would generate on its own depreciation schedule.

The following is a hypothetical illustration only. Your results depend entirely on your property's cost, components, ownership structure, and tax situation — treat these numbers as an illustration of the mechanics, not a projection.

Suppose an investor buys a $650,000 short-term rental cabin near Pigeon Forge and places it in service in 2026, with $130,000 allocated to land and $520,000 to depreciable building and site improvements. A cost segregation study identifies roughly $130,000 of that basis — furnishings, appliances, decking, a hot tub, driveway, and landscaping — as 5-, 7-, and 15-year property.

On the federal return, that $130,000 qualifies for OBBBA's 100% bonus depreciation, producing a $130,000 first-year federal deduction instead of a share of a 27.5-year schedule. If the cabin is owned directly by an individual, or by a family LLC that qualifies for Tennessee's FONCE exemption, that is the end of the story — Tennessee has no income tax return on which a different depreciation rule could apply. But if the cabin sits in an LLC that is subject to Tennessee's franchise and excise tax, the state's 2026 conformity cap allows only 20% bonus depreciation for F&E purposes — about $26,000 — with the remaining $104,000 recovered through ordinary depreciation on the Tennessee excise return in later years. The federal deduction is not reduced; the Tennessee entity-level deduction is simply spread out differently in the near term.

Cost segregation is not limited to the year of purchase. An investor who bought or built a Tennessee property in a prior year and never had a study performed can still capture the missed acceleration through a look-back study. The mechanism is IRS Form 3115, Application for Change in Accounting Method, which reports the difference between depreciation already claimed and depreciation that should have been claimed as a one-time Section 481(a) catch-up adjustment in the current tax year. No amended returns are required for the years already filed — the correction is made going forward, which is typically faster and simpler than reopening prior filings.

Cost segregation tends to make the most sense for:

• Short-term rental and Airbnb owners in the Smoky Mountains cabin markets — Gatlinburg, Pigeon Forge, Sevierville, and Wears Valley — where furnishings, decks, hot tubs, and landscaping typically make up a meaningful share of total property cost
• Long-term rental property owners in Nashville, Chattanooga, Memphis, and other Tennessee markets with a stabilized rental portfolio
• Recent buyers and owners who have renovated, since a study can be timed to the purchase, a major renovation, or a look-back on a property placed in service years ago
• High-income earners using the short-term-rental strategy — under the federal average-stay rule (Treasury Regulation 1.469-1T(e)(3)(ii)), a rental with an average guest stay of seven days or less is generally not treated as a passive rental activity, so an owner who materially participates in operating it may be able to apply the resulting loss against active or W-2 income rather than having it trapped as a passive loss. This strategy turns on meeting specific material-participation tests and should be reviewed with a tax professional before relying on it
• Owners weighing an LLC versus direct ownership, given that the choice affects whether Tennessee's franchise and excise tax — and its separate, decoupled bonus depreciation conformity — applies at all