1. What a cost segregation study does
A building normally depreciates over 27.5 years (residential) or 39 years (commercial). A cost segregation study breaks the purchase price apart and reclassifies components like flooring, cabinetry, dedicated electrical, and land improvements into 5, 7, and 15-year property, so a large slice of the basis depreciates on much shorter schedules.
On the federal return, that reclassified property also qualifies for bonus depreciation, which restores a 100% first-year write-off for qualifying property acquired and placed in service after January 19, 2025. States set their own rules, which is where Tennessee comes in.
2. Tennessee and federal bonus depreciation
There is no individual income tax in Tennessee, so bonus depreciation is irrelevant for personally held property. For the entity-level excise tax (6.5% on net earnings of LLCs, LPs, and corporations), the Tennessee Works Tax Act of 2023 (Public Chapter 377) coupled Tennessee to IRC 168(k) only as it existed under the TCJA, for assets purchased on or after Jan 1, 2023: 80% (2023), 60% (2024), 40% (2025), 20% (2026), 0% (2027 and after). TN DOR Notice #25-36 (Dec 2025) confirms Tennessee did NOT adopt the OBBBA's permanent 100% bonus: taxpayers must keep applying the TCJA phase-down percentages for excise tax, and the OBBBA's new 168(n) qualified production property 100% deduction is likewise not allowed. Assets purchased on or before Dec 31, 2022 get zero bonus for Tennessee purposes.
Per Notice #25-36: add back the excess federal bonus on Schedule J, Line 3 of the excise tax return (e.g., $50,000 asset placed in service Aug 2025 gets 100% federal bonus but only 40%/$20,000 for Tennessee; the $30,000 excess is added back), then recover the added-back basis over the asset's regular federal MACRS recovery life, deducting the corresponding depreciation on Schedule J, Line 16. Post-2023 adjustments ride the same Schedule J lines historically used for pre-2023 assets.
Worked example
A $1,000,000 building, with and without a study
Illustrative only. A residential rental purchased for $1,000,000 of building basis (land excluded), acquired and placed in service after January 19, 2025.
Building basis
$1,000,000
Reclassified to 5, 7, and 15-year property (25%)
$250,000
Federal first-year deduction at 100% bonus
$250,000
Year 1 on that $250,000 without a study (27.5-year straight line)
about $9,100
Tennessee allows only part of the federal bonus deduction. Per Notice #25-36: add back the excess federal bonus on Schedule J, Line 3 of the excise tax return (e.g., $50,000 asset placed in service Aug 2025 gets 100% federal bonus but only 40%/$20,000 for Tennessee; the $30,000 excess is added back), then recover the added-back basis over the asset's regular federal MACRS recovery life, deducting the corresponding depreciation on Schedule J, Line 16. Post-2023 adjustments ride the same Schedule J lines historically used for pre-2023 assets.
Model your own numbers with the tax strategy projector.
3. Section 179 in Tennessee
Per TN DOR guidance ET-3, IRC Section 179 expense is deducted for excise tax purposes to the same extent it was deducted on the corresponding federal return; Tennessee has never decoupled from 179 and imposes no separate state cap, so the OBBBA-increased federal limits (up to $2.5M expensing, $4M phase-out, indexed) flow through to the Tennessee excise tax.
4. Does it still help in Tennessee?
Yes. Tennessee fully follows federal MACRS classifications and recovery periods for excise tax, so reclassifying components into 5/7/15-year property still front-loads deductions on the Tennessee return, and those reclassified assets also get the partial TCJA-schedule bonus (40% if placed in service in 2025, 20% in 2026) with the disallowed remainder recovered over regular MACRS lives; investors holding property personally or in a FONCE-exempt entity feel no state drag at all.
- •No individual income tax: the Hall tax (interest/dividends only, never rental income) was fully repealed effective Jan 1, 2021, so personally held rentals owe zero Tennessee income tax and get full federal bonus benefit with no state haircut.
- •Tennessee taxes LLCs and LPs at the entity level: the franchise and excise tax (6.5% excise on net earnings plus franchise tax of $0.25 per $100 of net worth, $100 minimum) hits pass-throughs that are exempt in almost every other state, so the bonus-conformity question lands on investor LLCs, not just corporations.
- •TN DOR Notice #25-36 (Dec 2025) confirms Tennessee stays on the TCJA phase-down despite OBBBA: 40% bonus for 2025 placements, 20% for 2026, 0% for 2027+, unless the legislature acts; excess federal bonus is added back on Schedule J Line 3 and recovered via regular MACRS on Line 16.
- •Assets purchased on or before Dec 31, 2022 get no Tennessee bonus at all; the 2023 Tennessee Works Tax Act coupling applies only to purchases on or after Jan 1, 2023.
- •The OBBBA's new IRC 168(n) 100% write-off for qualified production property is NOT allowed for Tennessee excise tax; such property must be depreciated as 39-year nonresidential real property with Schedule J adjustments.
- •FONCE exemption: family-owned non-corporate entities (at least 95% family-owned LLC/LP/LLP) with at least 66.67% of income from passive investment or residential rental (4 or fewer units per location) are fully exempt from F&E tax; commercial and industrial rentals have not qualified since the 2009 law change, and the exemption must be claimed annually.
- •Tennessee Works Tax Act also added a $50,000 standard excise-tax deduction against net earnings, and 2024 legislation repealed the alternative property measure of the franchise tax (now net-worth only), both softening the F&E bite on small rental entities.
5. The exit: recapture and timing
The accelerated deductions come back into view when you sell. Gain attributable to the 5, 7, and 15-year property is Section 1245 recapture, taxed at ordinary rates, and the straight-line depreciation on the building itself is unrecaptured Section 1250 gain, taxed at up to 25%. A study does not create that bill, it moves deductions forward, but the timing of the sale decides how much of the benefit you keep.
Two levers manage the exit. A 1031 exchange defers both flavors of recapture along with the rest of the gain, and simply holding the property lets the time value of the early deductions do its work; most owners want a 3 to 5 year horizon before a taxable sale for the math to stay comfortably positive. Model the exit before you commission the study, not after.