Franchise Tax in Real Estate

What is a Franchise Tax?

Franchise tax (also known as privilege tax) refers to a type of tax paid to some states in order to be chartered or to operate in that state. The details behind franchise taxes vary from state to state and some states even hold companies that are chartered in another state liable for taxes. 

Franchise tax is separate from federal and state income taxes. However, they are required to be filed annually in addition to these two other taxes. 

Nonprofits, fraternal organizations, and limited liability corporations are some examples of organizations that may be exempt from franchise taxes, but please consult a tax expert for official tax advice.

Franchise vs. Income Tax

Unlike franchise taxes, income taxes depend on how much profit a company makes in a certain year. Franchise taxes must be paid regardless of profit. The amount of franchise tax needed to be paid varies depending on the tax rules of the state. For example, some states may calculate it based on assets or net worth, while others may calculate based on the value of the company’s capital stock. 

In addition, income tax payments are required from all corporations that bring in income from sources in the state, regardless of whether they conduct business there or not. “Conducting business” may be defined differently based on the individual state and some other factors they depend on include employees, physical presence, etc.

Franchise Tax in Real Estate

Real estate entities that are not subject to franchise tax include real estate mortgage investment conduits and certain qualified real estate investment trusts (REITs). 

Franchise tax is included in operating expenses. They work similar to insurance and property taxes in a real estate financial model as it will have an impact on the net operating income (NOI). Like operating expenses, franchise tax can be reimbursed. 

Example: Here is an example of franchise tax using the multifamily acquisitions model from Top Shelf Models:

In the assumptions and annual cashflows section of the acquisitions model, we can see that the franchise tax falls in operating expenses and is deducted in order to calculate the net operating income (NOI). 

Conclusion

Franchise taxes (privilege tax) are additional taxes that apply to businesses and real estate depending on a state’s tax laws. They differ from state and federal income taxes as they are not dependent on a corporation’s profit. In addition, some entities do not have to pay franchise taxes. Examples include: REITs, nonprofits, some LLCs, etc. 

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About the Author

Eric Bergin is the founder of TSM. He realized that there was a need for real estate financial models that were more than just generic templates. He wanted to create a personalized product for his customers that would ensure success for them and their company. Please reach out to him if you have any questions regarding discounted cashflows or if he can help you with your modeling needs.