Alabama Form NR-AF3: Claiming the 1031 Exemption From Nonresident Withholding

Alabama withholds 3% or 4% of the price from nonresident sellers, with a $300,000 floor

Section 40-18-86 is an income tax withholding statute, not a transfer tax. When a nonresident of Alabama sells real property and associated tangible personal property, the buyer withholds a percentage of the purchase price and remits it to the Department of Revenue, and the seller later claims it as an estimated payment on the Alabama return. The statute sets the rate by who is buying: three percent for individual buyers, four percent for corporate, partnership or unincorporated association buyers.

Nonresidents include individuals, trusts, partnerships, corporations, LLCs and estates whose principal residence or principal place of business is outside Alabama. Alabama residents and entities domiciled in Alabama are outside the law entirely and sign none of the forms. A nonresident who has filed Alabama returns for the two prior years, stays in business or keeps property in the state, and will report the sale can swear to deemed residency on Form NR-AF1.

Two limits soften the math. The Commissioner set a purchase price threshold of $300,000, below which nothing is withheld, and withholding can never exceed the net proceeds otherwise payable to the seller after mortgage payoffs and closing costs. A seller who would otherwise be over-withheld can also file Form NR-AF2, Affidavit of Seller's Gain, so the 3% or 4% applies to the recognized gain instead of the price.

A completed exchange is a non-recognition transaction, so nothing is withheld

The Department's withholding package lists the exemptions, and item K reads: transfers of real property where gain is realized by the seller but completely not recognized by the seller for Alabama income tax purposes, such as a like kind exchange, are not subject to the withholding provisions of section 40-18-86. Alabama computes exchange gain under federal section 1031, so a fully deferred federal exchange is fully deferred for Alabama and falls squarely within the exemption.

Form NR-AF3, Seller's Certificate of Exemption (revised 9/25), carries that language as one of its initial lines: the transaction is a non-recognition transaction such as a like kind exchange where gain is realized by the seller but completely not recognized for Alabama income tax purposes. The seller initials the line, signs under penalty of perjury before a notary, and hands the form to the buyer.

The Department is explicit that the certificate is not required and should not be submitted. Its purpose is the buyer's protection: the buyer may rely on the seller's affidavit unless the buyer knows or should know, based on knowledge at closing, that a statement is false, and the buyer has no duty to investigate. Because the buyer is personally liable for unwithheld tax, every closing attorney will want the NR-AF3 in the file, which is why you should treat it as mandatory even though the regulation does not.

The deferred-exchange condition puts your qualified intermediary on the hook

The Department's FAQ on section 1031 draws a line between simultaneous and deferred exchanges. For a deferred exchange, the transaction qualifies for the exemption only if the seller agrees to have the qualified intermediary file the required payment voucher and remit any withholding due to the Department in the event that monies remain after the 180-day deferral period.

In practice that means the exchange agreement, or a side letter signed at closing, should say that if the exchange fails in whole or part, the intermediary will complete Form WNR on the seller's behalf and send the withholding with Form WNR-V before releasing the balance. Ask the intermediary to confirm it will do this before you sign the NR-AF3; some will not, and a seller who certifies the exemption without the undertaking has not met the Department's condition. What an intermediary needs to open the exchange, and what it does with unused funds after day 180, are covered elsewhere.

Reverse and improvement exchanges run through an exchange accommodation titleholder rather than a simple intermediary account, and the Department's FAQ does not address them. The safer reading is that the same undertaking should be obtained from whichever party will hold Alabama sale proceeds beyond closing.

Boot and failed exchanges: what gets remitted, by whom and when

If part of the gain is recognized, the exemption shrinks to match. The package says transfers where gain is partially not recognized are subject to withholding only to the extent of the recognized gain, and gives the example of a section 1031 exchange where monies received by the seller exceed the exchange transaction. The seller states the recognized gain on Form NR-AF2, the buyer applies 3% or 4% to that figure on Form WNR, and remits it with Form WNR-V.

Hypothetical: an individual buys a $900,000 Huntsville fourplex from a nonresident who sends $840,000 to the intermediary and takes $60,000 at closing. Recognized gain of $60,000 at the 3% individual-buyer rate means $1,800 withheld, due with the voucher by the last day of the month after the closing month; the seller claims it on the Alabama nonresident return by attaching Form WNR. Run your own numbers with your CPA, since how much of the boot is gain depends on basis and expenses.

When a deferred exchange fails outright, the intermediary's undertaking kicks in: it files WNR and WNR-V and remits 3% or 4% of the gain, capped at the funds it holds, before returning the rest. The seller then reports the full sale on the Alabama return for the year the gain is recognized and takes credit for the remittance. Alabama has no annual form that tracks deferred gain afterward, so a successful exchange into property in another state ends the Alabama filing trail.

What belongs in the closing file for an Alabama exchange

The Department's forms are designed to be kept rather than filed when the exemption applies, so the file is the proof. Assemble it before closing, not after, because the buyer's reliance has to be in good faith at the time of the transfer.

Separate forms are required for each nonresident seller who will file an Alabama return, and co-owners' residency is tested separately: a resident co-owner signs nothing while the nonresident co-owner exchanges with an NR-AF3. The general rules on state withholding and the pre-sale checklist cover the federal side of the same closing.

• Form NR-AF3 with the non-recognition line initialed, signed before a notary, retained by the buyer
• The exchange agreement and assignment showing the qualified intermediary as the party receiving proceeds
• The intermediary's written agreement to file Form WNR and WNR-V and remit if funds remain after day 180
• Form NR-AF2 and a basis explanation if any gain will be recognized at closing
• Copies of Form WNR for the seller's return if anything was withheld