1031 Exchange in Alabama: Nonresident Withholding, Deed Tax and 5% Rate

Section 40-18-8(c) computes Alabama exchange gain under federal §1031

Alabama does not merely tolerate like-kind exchanges; its income tax code says that if an exchange satisfies 26 U.S.C. §1031, the gain or loss recognized is determined under that federal section (Ala. Code §40-18-8(c)). A property owner who defers gain on a federal Form 8824 therefore reports no Alabama gain on the same transaction.

Because the conformity sits in the gain-recognition statute itself, there is no separate Alabama election, addition or schedule to complete. What Alabama asks for instead happens at the closing table, through the nonresident withholding rules described below.

If the exchange fails, or boot is received, the recognized portion is Alabama taxable income in the year of sale, using the same brackets that apply to wages. Read the federal mechanics of an exchange first; the rest of this page is about the Alabama layer.

Alabama's 5% bracket begins at $3,000, so nearly all of a taxable gain is taxed at the top rate

Alabama taxes capital gains as ordinary income with no long-term discount. The Department of Revenue's rate schedule is 2 percent on the first $500 of taxable income, 4 percent on the next $2,500 and 5 percent on everything over $3,000 for a single filer (over $6,000 on a joint return), so a six-figure gain from a taxable sale would be taxed almost entirely at 5 percent.

One feature softens that: Amendment 225 to the Alabama Constitution (ratified 1965) provides a deduction for federal income taxes paid by individual taxpayers. A large federal capital-gains bill in the year of a taxable sale would therefore reduce the Alabama tax for that same year; how much depends on your return, which is a question for your CPA.

A completed exchange sidesteps both calculations, because no Alabama gain is recognized. The comparison a seller should run is the 5 percent Alabama tax, net of the federal deduction, against the cost and constraints of exchanging.

Nonresident sellers: the §40-18-86 withholding and the like-kind exemption

Ala. Code §40-18-86 requires the buyer of Alabama real property from a nonresident to withhold and remit tax to the Department of Revenue. Under the statute's text the rate turns on who the buyer is: 3 percent of the purchase price for an individual buyer, 4 percent for a corporate, partnership or unincorporated-association buyer. Alabama residents, and business entities domiciled in Alabama, are outside the statute and file none of these forms.

The Department's exemption list includes transfers where gain is realized but not recognized for Alabama income tax purposes, which is exactly what a completed like-kind exchange produces. Where gain is only partly deferred, for example because the seller takes cash that exceeds the exchange, withholding applies to the recognized gain alone.

For a deferred exchange the Department adds a condition: the exemption holds only if the seller agrees that the qualified intermediary will file the payment voucher and remit any withholding due if money remains in the exchange account after the 180-day exchange period. That makes the choice of qualified intermediary an Alabama compliance decision, not just a federal one.

Nothing is withheld on any sale priced below $300,000, the threshold the Department set for transfers after December 31, 2008.

• Form NR-AF1: the seller's affidavit of Alabama residency, or request to be treated as a deemed resident
• Form NR-AF2: affidavit of seller's gain, which lets the buyer withhold on gain instead of price when part of an exchange is taxable
• Form NR-AF3: seller's certificate of exemption; the Department suggests buyers obtain it to document reliance on the like-kind exemption
• Forms WNR and WNR-V: the withholding return and payment voucher the buyer or intermediary files if any amount must be remitted

Alabama's $0.50-per-$500 deed tax applies to the replacement deed, exchange or not

Alabama has no transfer tax in the usual sense, but it levies a recordation tax on deeds of $0.50 per $500 of value, or fraction of $500 (Ala. Code §40-22-1), and $0.15 per $100 of indebtedness on a recorded mortgage. A like-kind exchange does not change either figure; the deed for an Alabama replacement property is taxed on its value like any other deed.

The tax is paid when the instrument is recorded, and the person submitting the deed must state the value; intentionally failing to submit proof of value, or presenting false proof, carries a penalty of $100 or 25 percent of the tax due, whichever is greater. On a $2 million Alabama purchase the deed tax is $2,000, a closing cost to budget on the replacement side rather than the relinquished side.

If the replacement is a DST holding property outside Alabama, no Alabama deed is recorded and this cost disappears from the Alabama side entirely; the property's own state sets the transfer tax on the sponsor's acquisition.

Class II at 20 percent: the property-tax side of selling an Alabama rental

Alabama assesses property in four classes (Ala. Code §40-8-1). Rental houses, apartments, offices and other property not otherwise classified fall in Class II, assessed at 20 percent of fair market value; owner-occupied residences plus agricultural and forest land are Class III at 10 percent. An investor who owns Alabama rentals is therefore assessed at twice the ratio of the homeowner next door, which is one reason Alabama landlords weigh an exchange into passive real estate.

Farm and timber land carries a second break: §40-8-1 allows Class III agricultural and forest property to be assessed on its current-use value rather than market value where the law provides. A buyer of exchanged farmland must requalify the land for current use with the county, so a seller should expect the buyer's lender and closing attorney to ask about it.

Alabama has no acquisition-value cap comparable to California's Proposition 13, so selling does not by itself trigger a new valuation; the county revenue commissioner values property on its own cycle.

No Alabama form tracks deferred gain after the exchange

Alabama requires no annual information return for gain deferred into out-of-state replacement property. Once the exchange closes and the withholding paperwork is filed, or shown to be unnecessary, the state has nothing further to collect until a later taxable disposition, and then only if the taxpayer is still an Alabama taxpayer or the property is in Alabama.

That is a real difference from California, whose Form FTB 3840 follows deferred gain for years. Exchanging Alabama property for property elsewhere does not create an Alabama filing tail.