Tennessee 1031 Exchanges and DSTs: Taxes, Cabins, Land, and Lake Property

By Jerry Baker

A Tennessee 1031 exchange can defer federal tax on gain when you replace qualifying business or investment real estate with other qualifying real estate. The next property still needs to work after taxes, permits, upkeep, and debt costs. I would compare direct ownership with a qualifying Delaware Statutory Trust interest based on your cash needs and the work you want to keep doing.

Decide what your next round of ownership should look like

A rental house, a cabin, a farm, and a lake property can all raise different questions. Start with the reason for selling. Are you tired of repairs? Do you want more steady income? Is the next generation unsure about keeping the land?

Be specific about the task you want to leave behind. A property manager might help with tenant calls while leaving you in charge of large repairs and loan decisions. A passive investment changes who makes those choices. Neither path removes the need to understand the asset.

I would also ask how much cash you need to keep outside the investment. A plan that looks fine over ten years may not work if you need that money in two. Discuss the household reserve before you decide how much to reinvest.

Give each option a clear job. One might support current income. Another might hold land for a longer period. If a purchase has to deliver high income, quick access to cash, low risk, and strong growth at once, we should revisit the wish list.

Keep the exchange rules separate from the sales pitch

Section 1031 generally covers real property held for investment or business. It does not cover a home used only as your residence or property held mainly for sale. Qualifying U.S. real estate can generally be exchanged for qualifying U.S. real estate in another state. Deferral does not mean tax disappears forever. Cash or other nonqualifying value received may leave taxable gain. [1]

In a typical delayed exchange, you have 45 days after the sale to identify replacements in writing. The purchase deadline is generally 180 days or your federal return's due date, including extensions, if earlier. Identification limits and control of the proceeds also matter. Put your qualified intermediary in place before closing so the funds move through the proper process. [2]

Ask the intermediary and your CPA to set out the amounts and dates in writing. The mortgage balance is not the tax basis. The sale price is not the cash you will have to invest. Loan payoff, closing costs, and tax treatment need separate lines on the worksheet.

I would work backward from the deadlines. Leave time for title, inspections, insurance quotes, financing, and signatures. A property should not reach the top of the list simply because it might close before the clock runs out.

The Hall tax repeal is not an answer to every tax question

Tennessee repealed its Hall income tax, which applied to certain interest and dividends, for tax periods beginning January 1, 2021, and later. That repeal should not be used as proof that a property transaction has no other state or federal tax cost. [3]

The Department of Revenue says corporations, limited partnerships, limited liability companies, and business trusts that fall within its registration rules generally must register for franchise and excise taxes unless an exemption applies. The exact entity and its activities matter. Ask your CPA to review the owner shown on the deed and the tax return. [4]

This is especially worth checking when someone says, “It is just our family LLC.” That describes who owns it. It does not establish every tax result. A change in owners, income, or property use may change the analysis.

Request estimates for a taxable sale and the proposed exchange. Show federal tax, Tennessee entity taxes if relevant, other state taxes, and closing charges separately. If an owner lives elsewhere, ask how that home state treats the transaction. Buying in Tennessee does not by itself change where a person lives for tax purposes.

Review the family-owned entity exemption before the sale

Tennessee's family-owned non-corporate entity exemption, often called FONCE, has specific tests. Generally, at least 95% of ownership must be held by qualifying family members, and at least 66.67% of activity must produce qualifying passive income or a combination of passive income and farming. The state defines the terms and requires an application and annual renewal. Its residential-rent definition generally covers four or fewer units at one location. [5]

Do not confuse that definition with a casual description of an investment as passive. The Revenue Department separately states that gains from the sale or exchange of assets other than stocks or securities are not included in its definition of passive investment income for FONCE. Ask your CPA how any recognized property gain affects the sale year's tests and filings. [6]

I would make this a pre-sale question. Give the CPA the ownership chart, prior exemption filings, rent detail, and expected settlement statement. Include any other income in the entity. Do not wait until tax preparation to learn that the sale changed a test you had been meeting.

Keep the exchange and exemption questions distinct. One concerns treatment of a property exchange. The other concerns an entity's tax status under a separate set of rules. The answer to one should not be guessed from the answer to the other.

Check the assessment class, not just last year's bill

The Tennessee Comptroller lists a 25% assessment ratio for residential and farm real property and 40% for commercial and industrial real property. Those percentages are parts of the property-tax calculation, not tax rates charged against the sale price. Ask the assessor how the exact property's use is classified and what changes after purchase. [7]

For an invented example, a $500,000 appraised value assessed at 25% produces a $125,000 assessment. At 40%, it produces $200,000. Neither number is the tax bill. The proper local tax rate and other applicable rules still have to be applied.

I would not assume that a house rented to vacation guests gets the same treatment as a house occupied by its owner. I would not make the opposite blanket assumption either. Get the property's record and written guidance from the office that will assess it.

When comparing two purchases, use a supported tax estimate for each. A low expense line is not a benefit if it rests on the wrong use, an old appraisal, or relief that the buyer will not receive.

Confirm which rental rules govern the address

The state Health Department explains that Tennessee's Uniform Residential Landlord and Tenant Act applies in counties with more than 75,000 people under the 2010 census. That is a specific census reference, not a test based on today's population estimate. Have Tennessee counsel confirm the rules for the county and lease involved. [8]

For an occupied rental, collect the signed leases, deposit ledger, repair requests, notices, and any payment agreements. Ask the manager to match the rent roll to bank receipts. A lease showing full rent does not prove that full rent was collected.

Review repairs through the tenant's eyes as well as the budget. An unresolved water leak is a habitability concern, a future repair expense, and a possible sign of weak management. A property can have a tidy spreadsheet and a poor operating record.

At closing, identify who gets the deposits and records, who tells tenants about the new owner, and who handles open repair requests. Put those tasks on the closing list. A change in ownership should not make an existing problem disappear from the file.

A Sevier County cabin needs more than booking history

Sevier County's short-term rental program covers units outside city limits and calls for an annual permit and inspection. City boundaries matter because a county program is not the same as a city's approval process. Confirm the property's actual jurisdiction before applying a checklist. [9]

The county's buyer guidance says an existing permit account can transfer to a buyer, who must submit a change-of-information application. It also directs buyers to check the certificate of occupancy, allowed use, application history, renewal date, and inspection reports. Raising occupancy may require added code review. A transferred account is not proof that every proposed use has been approved. [10]

I would request a month-by-month booking record, not just the best month. Separate rent, cleaning charges, refunds, taxes collected, platform fees, and manager fees. Note which dates the owner blocked for personal use.

Then ask whether the new owner can reproduce those results. Will the manager stay? Can the booking account and reviews transfer under the platform's rules? Are reservations being assigned? Will any guests receive refunds because of the sale?

Consider a hypothetical cabin with $90,000 of annual guest receipts. If $8,000 consists of taxes collected and $12,000 covers cleaning charges passed through to cleaners, those items are not $20,000 of owner profit. That leaves $70,000 before other expenses, debt service, reserves, and income taxes. This example uses invented figures, not a local earnings forecast.

A good view may help attract a guest. It does not pay for a new heat pump. Add reserves for furniture, appliances, roof work, roads, and other known needs before deciding how much income you can spend.

Match the floor plan to the septic record

TDEC says an increase in bedrooms or construction that affects an existing septic system may need a modification permit. It directs owners to obtain required permits before dirt work or construction. Certain counties, including Sevier County, handle these services locally instead of through the state's online application. Use the right office for the address. [11]

Compare the septic file, building plans, certificate of occupancy, and advertised sleeping capacity. A room with a bed is not evidence that all approvals allow another bedroom or more guests. Ask a qualified local professional to identify any mismatch.

If the investment plan depends on adding bedrooms, obtain a feasibility review and a cost estimate before counting the added rent. Include any loss of rental days during work. Also find out where the reserve drain field is; the spot chosen for a pool or outbuilding may have another purpose.

I would value the property first on the use that is approved and supportable today. Treat a future expansion as a separate project with its own cost, timing, and approval risk.

Verify the dock rights with the lake property

For properties subject to TVA shoreline rules, a Section 26a permit does not transfer automatically with the sale. TVA says the new owner must notify it within 60 days and apply for the existing facilities. A transfer also depends on whether the facilities were permitted and match what was approved. An altered or unapproved dock may require a new permit request. [12]

Get the permit drawing and compare it with the dock, walkway, steps, and shoreline work on site. Ask who owns the land between the house and the water. Check any access agreement or association rules that affect use.

I would also ask how the property works when water levels change. Can the boat still reach the dock? Who maintains access? What is the cost of repairing shoreline structures? Use records and an inspection rather than a photo taken on an ideal day.

The words “lake access” can describe very different rights. A shared launch, a private dock, and a view across someone else's land should not be valued as though they are the same thing.

Greenbelt tax treatment deserves its own closing review

Tennessee's greenbelt program values qualifying farm, forest, and open-space land by present use rather than its highest possible use. First-time applications are generally due March 15. A change in ownership as of the January 1 assessment date requires reapplication. Forest qualification also requires a forest management plan. Ask the county assessor how the specific tract meets acreage and use tests. [13]

When land no longer qualifies, rollback taxes may recover the difference between use-value taxes and regular taxes. The state describes a three-year lookback for agricultural and forest land and five years for open-space land. Confirm the calculation, trigger, and responsible party before signing a contract. [13]

A seller may describe land as “ready for cabins” while the tax bill reflects continued farm or forest use. Those two pictures may not belong in the same budget. Ask for a written plan showing what happens to taxes as the use changes.

Review land access with equal care. Who maintains the road? Do recorded rights reach the part you plan to use? Where are power and water? An attractive price per acre does not tell you what a usable site will cost.

Compare direct property and DSTs on the same basis

IRS Revenue Ruling 2004-86 addresses a specific DST structure whose interests were treated as interests in real estate for Section 1031 purposes. The ruling does not make every trust or fund eligible. Counsel and your tax team should review the proposed interest and exchange structure. [14]

For direct property, include management, repairs, taxes, insurance, debt service, and reserves in the income estimate. For a DST, ask how the forecast handles those costs, along with fees and the sponsor's business plan. Compare cash available to you, not two numbers with different expenses removed.

A DST may reduce your daily work, but it also means relying on others. Ask who decides when to sell, how the debt works, and what could reduce distributions. Look at the properties and leases behind the offering, not just the proposed payout.

The SEC warns that private placements can carry substantial risk, limited disclosures, and restrictions on resale. Investors can lose their investment. Being eligible to buy one does not mean it fits your household or that you can sell when you need cash. [15]

I would want the final choice to make sense even after a less pleasant year. What happens if bookings fall, a tenant leaves, insurance costs rise, or a sale takes longer? That conversation belongs before the purchase, while you still have choices.

Frequently asked questions

Can I exchange Tennessee property for property in another state?

Generally, qualifying U.S. investment or business real estate can be exchanged for other qualifying U.S. real estate. Each property and the transaction must meet the rules. Ask your CPA about state treatment and filings as well as the federal exchange. [1]

Does the Hall tax repeal mean my LLC has no Tennessee tax?

No. The Hall tax repeal and entity franchise and excise taxes are separate matters. Have your CPA review the entity, its activities, and any exemption requirements. [3] [4]

Can I rely on the seller's short-term rental permit?

Get the permit file and verify the process for the exact jurisdiction. Sevier County's guidance calls for ownership updates and review of occupancy and inspection records; that does not approve every change a buyer may want. [10]

Will a TVA dock permit transfer with my deed?

Not automatically. TVA requires notice from the new owner and an application, and the existing structures must be checked against prior approval. Put the permit task on the closing plan. [12]

Can greenbelt taxes change when I buy land?

Yes. Ownership changes can require reapplication, and a loss of qualifying use can bring rollback taxes. Ask the assessor for a parcel-specific review rather than relying on the seller's bill. [13]

Is a DST a liquid substitute for owning a rental?

No. A private DST offering can have serious resale limits and investment risks. Review your cash needs, the offering documents, and the expected holding period before making a choice. [15]

Educational information, not an offer or a personal tax, legal, or investment recommendation. Examples are hypothetical and omit stated adjustments. Tax treatment depends on your facts and current law. Review your transaction with your CPA, attorney, and qualified intermediary. Real estate investments can lose value and may be illiquid.