A 1031 exchange is a tax strategy that allows you to defer paying capital gains taxes when you sell an investment property, as long as you reinvest the proceeds into a new, like-kind property. This means you can sell one property and buy another similar one without immediately paying taxes on any gains from the sale.
These like-kind exchanges are covered under Section 1031 of the Internal Revenue Code (hence the name "1031 Exchanges") and apply to federal capital gains taxes. However, each state has their own tax code, and may have different rules for real estate tax withholdings, the ability to complete a tax-deferred sale, or the rules around like-kind exchanges. Below we'll dive deep into these state-level specifics.
In Alabama, the real estate tax withholding rules for nonresidents require withholding at a rate of 3% of the sales price for individuals and 4% for business entities. This applies to sales or transfers of real property and associated tangible personal property by nonresidents of Alabama. Nonresidents include individuals, trusts, partnerships, corporations, limited liability companies, limited liability partnerships, and unincorporated organizations.
There are exemptions available, such as using the seller's gain to calculate withholding instead of the sales price. To apply this method, the seller must complete Form NR-AF2 (Affidavit of Seller’s Gain) and submit it to the Alabama Department of Revenue (ALDOR). The buyer can rely on the seller's affidavit unless they know or should know that the statements are false.
Additionally, sellers can apply for an exemption by submitting Form NR-AF3 (Seller’s Certificate of Exemption). If the calculated withholding amount exceeds the cash received at closing, the buyer is only required to withhold and remit the net proceeds payable to the seller.
For more detailed information and forms, you can visit the Alabama Department of Revenue's website on nonresident withholding: Alabama Department of Revenue - Nonresident Withholding.
Alabama allows taxpayers to deduct federal income taxes from their state taxable income. The Combined Rate accounts for Federal, State and Local tax rates on capital gains income, the 3.8 percent Surtax on capital gains and the marginal effect of Pease Limitations (which results in a tax rate increase of 1.18 percent).
For single taxpayers with AGI below $23,000, the standard deduction is $2,500. This standard deduction amount is reduced by $25 for every additional $500 of AGI, not to fall below $2,000. For Married Filing Joint taxpayers with AGI below $23,000, the standard deduction is $7,500. This standard deduction amount is reduced by $175 for every additional $500, not to fall below $4,000. For all taxpayers claiming a dependent with AGI of $20,000 or less, the dependent exemption is $1,000. This amount is reduced to $500 per dependent for taxpayers with AGI above $20,000 and equal to or less than $100,000. For taxpayers with over $100,000 AGI, the dependent exemption is $300 per dependent. Alabama allows taxpayers a deduction for total federal tax liability from their federal return less any federal tax credits claimed.
Many states recognize and follow the federal rules for a qualifying 1031 exchange. We recommending reviewing these resources for 1031 exchanges at the federal level - learn about the rules for an exchange, the key deadlines you must meet, and why you are required to work with a Qualified Intermediary like Deferred.com.
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