Out-of-State Landlord Tax Guide 2026: Tennessee & Kentucky Edition

Owning a rental in Tennessee or Kentucky from another state changes your tax picture in ways that surprise a lot of first-time landlords. You may owe state income tax in a state you don't live in. You may qualify for federal deductions that are worth more than the rent income itself in year one. And 2026 specifically brought back a major depreciation break that shifts the math for anyone who did a renovation this year.

Here's the plain-English breakdown.

The federal side — what every landlord gets

Deductible operating expenses

Anything ordinary and necessary to run the rental is deductible against rental income:

• Mortgage interest
• Property taxes
• Insurance (landlord policy, umbrella if you have one)
• Property management fees
• Repairs and maintenance (not capital improvements — see below)
• HOA dues
• Utilities if you pay them
• Legal and professional fees (CPA, attorney)
• Advertising and marketing to fill vacancies
• Travel to and from the property for legitimate business purposes

Depreciation — the deduction you can take even when you have positive cash flow

The IRS lets you deduct depreciation on the building (not the land) over 27.5 years. For a $300,000 property where the land is worth $60,000 and the building is worth $240,000, that's roughly $8,700 per year in depreciation you get to deduct — often reducing taxable rental income to zero even when the property is cash-flow positive.

Key rule: depreciation isn't optional. If you don't claim it, the IRS still assumes you did when you eventually sell (this is called "depreciation recapture"). So you might as well claim it every year.

The 2026 game-changer: 100% bonus depreciation restored

The One Big Beautiful Bill Act (OBBBA), signed in 2025, permanently restored 100% bonus depreciation for qualifying assets placed in service after January 19, 2025. What this means for landlords:

• Certain property improvements with a useful life of 20 years or less — appliances, carpet, cabinets, HVAC in some cases, land improvements like fences or landscaping — can be fully deducted in the year placed in service instead of depreciated over 5, 7, or 15 years.
• Combined with a cost segregation study, this can turn a $400,000 rental purchase in 2026 into a five-figure or even six-figure first-year deduction.

If you bought a rental in Nashville or Lexington in 2025 or 2026 and haven't asked your CPA about cost segregation, you may be leaving five figures on the table.

Passive activity loss rules — the $25,000 exception

Rental income is generally treated as passive by the IRS, which means rental losses can only offset other passive income (not your W-2 salary). But there's a carve-out:

• If you actively participate in the rental (make management decisions, approve tenants, etc. — hiring a PM does not disqualify you), you can deduct up to $25,000 of rental losses against your regular income.
• This deduction phases out between $100,000 and $150,000 of modified adjusted gross income ($50,000 - $75,000 if married filing separately).
• Above $150,000 MAGI, the $25,000 rule is gone. Losses just carry forward until you have passive income or sell the property.

Tennessee — the state side (Nashville landlords)

The good news: no state income tax on rental income

Tennessee does not tax individual earned or rental income. If you're an out-of-state owner whose only Tennessee income is rental income, you generally do not need to file a Tennessee state return.

The gotcha: business tax and franchise tax if you're structured as an LLC

If your rental is held in an LLC (regardless of where the LLC is registered), Tennessee may impose:

• Franchise and Excise (F&E) tax on the LLC itself, unless the LLC qualifies as a Family Owned Non-Corporate Entity (FONCE) or otherwise exempt. Rental-property-only LLCs often qualify for the FONCE exemption if 66.67%+ of the members are family and the primary activity is passive investment. Filing is still required to claim the exemption.
• Business tax at the county and municipal level in some cases — usually low ($15-$100/yr) if applicable.

Property tax

Davidson County (Nashville) assesses residential property at 25% of appraised value and taxes it at the current rate, which as of 2026 is roughly $3.25 per $100 of assessed value in the Urban Services District and lower in the General Services District.

For a $300,000 Nashville rental, expect roughly $2,400 - $3,100/year in property tax. This is fully deductible on your federal return.

Kentucky — the state side (Lexington landlords)

Kentucky does tax rental income at the state level

Kentucky imposes a flat 4% individual income tax (as of 2026, with proposed reductions on the horizon). If you're an out-of-state owner with Kentucky rental income, you generally need to file a Kentucky nonresident return (Form 740-NP) and report the rental income.

The good news: most of the federal deductions carry through, so your Kentucky taxable rental income is usually much lower than gross rents.

The reciprocity check

Kentucky has income tax reciprocity agreements with some neighboring states (Illinois, Indiana, Michigan, Ohio, Virginia, West Virginia, Wisconsin). If you live in one of those states, wage income from Kentucky doesn't get double-taxed. However, reciprocity does not apply to rental income. Rental income is always taxed where the property is located.

Kentucky LLC filing requirements

If you hold a Kentucky rental in an LLC, the LLC generally must:

• Register with the Kentucky Secretary of State (foreign LLC registration if the LLC was formed elsewhere)
• File an annual report and pay a small annual fee
• File a Kentucky Limited Liability Entity Tax (LLET) return if gross receipts exceed certain thresholds

Property tax

Fayette County property tax runs roughly 1.05% - 1.15% of assessed value for residential properties in Lexington, combining state, county, and school district rates. For a $250,000 Lexington rental, expect roughly $2,600 - $2,900/year. Fully deductible on your federal return.

Common mistakes we see out-of-state owners make

1. Not tracking cost basis properly at purchase

Your cost basis for depreciation is the building value only — not the total purchase price, and not the assessed value. Most owners just use the county assessor's building/land split, which is often wrong (usually favoring land, which reduces depreciation). Get an actual appraisal or ask your CPA whether the assessor split is defensible. A better split can add $2,000+ per year to your depreciation deduction.

2. Confusing repairs and improvements

A repair keeps the property in ordinary condition (fixing a leaky faucet, patching drywall, painting one room). These are fully deductible in the year incurred.

An improvement adds value or extends life (new roof, HVAC replacement, kitchen remodel). These must be capitalized and depreciated over 5-27.5 years, though 2026's bonus depreciation may allow many to be deducted in year one.

The line matters because it affects when you get the deduction — this year vs over decades.

3. Forgetting the Qualified Business Income (QBI) deduction

Rental activities that rise to the level of a "trade or business" may qualify for the 20% QBI deduction on rental income. The IRS provided a safe harbor: 250+ hours per year of rental services performed by the owner, PM, or contractors, plus separate books, and enterprise records. If your PM is doing the 250 hours, that likely counts toward your QBI qualification.

4. Missing state filings when you own through an LLC

Even if you owe nothing, most states — including both Tennessee (F&E) and Kentucky (LLET, annual report) — require the LLC to file returns. Missing them triggers penalties and can eventually cause the LLC to be administratively dissolved, which puts your liability protection at risk.

Records to keep, year-round

• Closing statement from purchase (this is your cost basis document)
• All improvement invoices with dates (for depreciation schedule and future sale)
• Every repair receipt (for annual deduction)
• Monthly owner statements from your PM (for income and expense reporting)
• Mortgage 1098
• Property tax bills
• Insurance premium receipts
• Travel logs for any trips to the property
• HOA statements if applicable

Your PM should be sending you the monthly statement and an annual 1099-MISC or 1099-NEC showing rents collected. If they don't provide a clean year-end summary, that's a red flag — talk to your CPA about switching.