The Four-Unit Line: How Tennessee's FONCE Exemption Decides Whether Your Memphis Rental LLC Owes Franchise and Excise Tax
Investors move to Tennessee partly because there is no tax on wage income, then hold their rentals in an LLC and assume the state is finished with them. It is not. Tennessee taxes the entity, and for a family-held rental company the difference between owing that tax and owing nothing frequently comes down to a single structural fact about one building.
The tax that surprises people
The Tennessee Department of Revenue is unambiguous about who registers: if you are a corporation, limited partnership, limited liability company or business trust chartered, qualified or registered in Tennessee, or doing business here, you must register for and pay franchise and excise tax. The excise tax is measured on the entity's net earnings; the franchise tax is measured on net worth, meaning total assets less total liabilities. The Department also states plainly that the minimum franchise tax is $100 and is payable if the company is registered through the Secretary of State to do business in Tennessee regardless of whether the company is active or inactive.
That last clause catches Shelby County, Tennessee owners who formed an LLC for a property they later sold, never dissolved it, and assumed a dormant entity is a free entity. It is not.
The exemption, and its two tests
The relief most family rental companies are actually relying on is the family-owned non-corporate entity exemption — FONCE — at Tenn. Code Ann. § 67-4-2008(a)(11). The Department's FONCE-1 guidance reduces it to two criteria, both of which must be met:
One. At least 95% of the entity's ownership must be held by family members. Two. Substantially all of the activity of the entity — which the Department quantifies as 66.67% — must be the production of passive investment income, or a combination of passive investment income and farming.
Test one is a conversation with your attorney about the operating agreement. Test two is where rental portfolios quietly fail, because Tennessee's definition of "passive" is narrower than the one investors carry over from their federal return.
Where the line actually falls
The Department says so directly in FONCE-7: it does not construe all real estate rents as passive investment income, and the state's classification may differ from federal law. Beginning July 1, 2009, it stopped considering rent received from commercial property to be passive income at all.
Then comes the sentence that decides most Memphis portfolios. For purposes of this exemption, property is industrial and commercial if it is classified that way for property tax purposes — except that all real property used, or held for use, for dwelling purposes that contains more than four rental units is defined as industrial and commercial property. Residential property, by the same rule, is dwelling property containing no more than four rental units.
"A duplex in Berclair and a fourplex in Cooper-Young produce passive income. The five-unit building next door does not. Nothing about the tenants changed — only the unit count under one roof."
The corollary matters just as much, and owners get it backwards constantly. FONCE-8 states that an entity may qualify even if it owns more than four separately deeded residential properties, and that there is no requirement it own four or fewer. Each property must simply contain no more than four rental units. Twelve separately deeded houses across the Raleigh, Frayser and Hickory Hill neighborhoods of Memphis, Tennessee are not a problem. One five-unit building is.
Running the 66.67% arithmetic
Because the test is proportional, a single non-conforming building does not automatically end the exemption — it eats into the margin. The following is an illustration of the mechanics, not a figure from any real portfolio.
Suppose a family-held LLC collects $180,000 in annual gross receipts: $150,000 from ten separately deeded single-family rentals in Shelby County, Tennessee, and $30,000 from one five-unit building. The passive share is $150,000 of $180,000, or 83.3% — comfortably above 66.67%. Now invert the weighting. The same entity earning $60,000 from houses and $120,000 from that five-unit building is at 33.3% passive, and fails outright. The building did not change. Its share of the receipts did.
This is why the exemption is worth modeling before the acquisition that tips the ratio, not at filing time. It is the same discipline we argued for around depreciation timing in the cost segregation post — the structural decision is cheap in advance and expensive in arrears.
What changed on July 1, 2026
The ownership half of the test just got more forgiving. SB1910 was enacted April 6, 2026 and amended the definition of "family-owned" for FONCE purposes, taking effect July 1, 2026. As PwC summarized the change, it broadens and clarifies which owners count toward the 95% threshold by expressly recognizing ownership held by qualifying relatives, trusts for their benefit, and estates of deceased qualifying relatives, and it updates the definition of "relative" to more clearly include certain spouse, former spouse and lineal descendant relationships.
The practical consequence for a Mid-South family that has been moving membership interests into trusts for estate planning: a structure that looked shaky against the 95% test last year may qualify cleanly now. If your entity was previously advised it did not qualify on ownership grounds, that conclusion is worth revisiting with your CPA this cycle.
The filing nobody remembers
The exemption is not self-executing. FONCE-1 requires an entity claiming it to file the Application for Exemption / Annual Exemption Renewal (Form FAE183) for the initial period and for every subsequent period claimed. It is due on or before the 15th day of the fourth month following the close of the taxable period, with an automatic seven-month extension where a federal extension has been requested. Missing it does not by itself cost you the exemption, but the Department may assess $200 per occurrence for late filing. The disclosure-of-activity section must always be completed, with all gross receipts from the federal return reported so the Department can verify the tests were met.
This one does not stop at the county line
We have written before about statutes that change character when you cross out of Memphis — the Uniform Residential Landlord and Tenant Act reaches Shelby County but not much of Fayette County, Tennessee's rural footprint, which we walked through in the deposit-rules breakdown. Franchise and excise tax is the opposite case. It is a state-level tax, so it lands identically on an entity holding rentals in Somerville or Oakland in Fayette County and one holding rentals in Collierville or Memphis. The four-unit line is drawn the same way in both counties.
Sizing it against everything else
Entity-level tax is one line in a stack that has been getting heavier. Tennessee assesses residential property at 25% of appraised value at rates quoted per $100 of assessed value, so a $180,000 appraised house inside Memphis carries the 2026 city rate of 2.58081 on top of the Shelby County rate of 2.702382 — a combined 5.283192, or roughly $2,377 a year. The same house in unincorporated Shelby County pays the county rate alone, near $1,216, plus the annual county fire fee tiered by structure square footage; we worked that split in the property tax post. On the debt side, Freddie Mac's Primary Mortgage Market Survey release dated August 13, 2026 put the 30-year fixed at 6.67%, down from 6.69% the prior week — a benchmark for owner-occupied, 20%-down, excellent-credit purchase loans, with rental financing pricing above it on both down payment and rate.
Against those numbers, an avoidable 6.5% excise charge on net earnings plus a net-worth-based franchise tax is not a rounding error. It is also the cheapest of the three to fix, because fixing it is a paperwork and structuring exercise rather than a market outcome.
Disclosure: alongside running Homefront, Matt is a licensed REALTOR®. If you buy or sell a property through him he is compensated on that transaction as well as on management. Using both is never a condition of either.
Before you sign on the five-unit
If you are weighing a small multifamily building in Shelby or Fayette County, Tennessee, the unit count belongs in the underwriting next to the roof age. Our team can model what the property does to your rent roll and your operating expenses; your CPA should model what it does to your exemption. Send us the address and we will handle our half. Management fees never exceed 10% of monthly rent, with a customized schedule as your portfolio grows and no hidden charges, and tenant screening is paid by the applicant — the full breakdown is in our fee guide. Get a free rent analysis to start.
Sources & further reading: Tennessee Department of Revenue — Franchise & Excise Tax overview, FONCE-1, Qualification and Filing Requirements, FONCE-7, Passive and Non-Passive Rent, FONCE-8, Several Multiunit Properties, Tennessee General Assembly — SB1910 (114th GA), PwC — Tennessee expands family-owned entity exemption ownership rules (May 19, 2026), Freddie Mac Primary Mortgage Market Survey, Freddie Mac PMMS release, August 13, 2026. Shelby County 2026 tax rates verified August 2026. Tax and statutory content is summarized as of August 2026 and may change; this article is general information, not legal, tax, or investment advice. Consult a Tennessee CPA or attorney about your specific entity.