Alabama Capital Gains Tax on Real Estate

If you’re thinking about selling a property in Alabama, it’s really important to understand how capital gains taxes work. After all, the way Alabama taxes your profits can make a big difference in how much cash you actually get to keep.

In this article, we’ll break down how Alabama handles taxes on real estate gains, what you might owe, and a few ideas to help lower your tax bill.

What are Capital Gains?

When you sell real estate for a profit, you may be taxed on a capital gain. A capital gain is the difference between what you sell the property for and its cost basis. The cost basis is usually what you paid for it, or its fair market value if you inherited it. It can also include adjustments for major improvements or selling expenses.

Now that we’ve covered what capital gains are, let’s look at a key way to reduce them when selling a home: the primary residence exclusion.

Primary Residence Capital Gains Exclusion

Selling your home can result in a large capital gain. Fortunately, the IRS primary residence exclusion can reduce or eliminate capital gains taxes on the sale of your home.

This federal rule, often called the Section 121 exclusion, sets the standard for avoiding those taxes, but how your state addresses the home sale exclusion is just as important.

Federal Capital Gains Exclusion

The IRS allows you to exclude up to $250,000 of capital gain ($500,000 for married couples) from the sale of your primary residence.

To qualify, you must have owned and lived in the home for at least two of the five years before the sale. These 24 months don’t have to be consecutive but must fall within the five-year window.

Any gain above the exclusion amount is subject to federal taxation.

Alabama Capital Gains Exclusion

While these federal rules are important, it’s equally critical to understand how Alabama handles capital gains on real estate.

Alabama follows federal rules for the primary home sale exclusion, so any federally excluded gain is also excluded from your Alabama taxable income. Any remaining gain is taxable at the state level.

Alabama Capital Gain Tax in 2025

The state of Alabama taxes capital gains at the same rate as ordinary income, with rates up to 5%.

Federal Capital Gains Tax in 2025

The IRS taxes capital gains separately from state income taxes. Short-term capital gains (assets held for one year or less) are taxed at your ordinary income tax rates. Long-term capital gains are taxed at preferential rates, based on your income level and filing status.

2025 federal long-term capital gains tax rates

These rates apply to profits from assets held over one year and sold in 2025 (reported on your 2026 tax return).

For a complete understanding of capital gains, including detailed definitions and how they are calculated, read our comprehensive guide: Capital Gains Tax on Real Estate.

To see how these concepts come together, let’s walk through how a real-world example would be taxed.

Case Study: Alabama Capital Gains Tax On Land Sale

Here’s a real-world example of calculating capital gains taxes for a vacant land sale.

Joseph bought a property for $125,000. He spent an additional $5,000 on improvements (such as bringing utilities to the property), so his cost basis is $130,000.

Eight years later he sells the property for $185,000. After deducting $15,000 in commissions and closing costs, his net proceeds are $170,000.

His capital gain is the net proceeds minus his cost basis: $170,000 - $130,000 = $40,000.

Joseph is single and has an ordinary taxable income of $80,000 (not including the land sale).

Alabama capital gains

The state of Alabama treats profit from selling property just like regular income, using the same tax rates. Joseph’s $80,000 in regular income is already high enough (as Alabama’s 5% bracket for Single filers starts at $3,000 or more) to put him into Alabama’s 5% tax bracket for any extra income. So, his $40,000 profit from the sale is also taxed at this 5% rate.

His state capital gain tax is $2,000 ($40,000 x 5%).

Federal capital gains

Joseph’s $40,000 profit qualifies for federal long-term capital gains tax rates, as he owned the property for more than a year.

The tax rate for long-term capital gains is determined by a taxpayer’s total taxable income. Since Joseph’s ordinary income of $80,000 places him above the 0% capital gains bracket, his capital gain will start to be taxed at 15%.

His total taxable income of $120,000 ($80,000 ordinary income + $40,000 capital gain) remains within the 15% federal long-term capital gains tax bracket.

Therefore, his $40,000 capital gain will be taxed at 15%, resulting in a federal capital gains tax of $6,000 ($40,000 × 15%).

Alabama Capital Gains Tax Calculator

Alabama taxes capital gains as ordinary income at the state’s regular income tax rates. Explore the state and federal rates with the calculator below.

How to Avoid Capital Gains On Alabama Real Estate

If you’re facing a big tax bill, there are several smart strategies you can use to reduce or defer capital gains taxes.

• 1031 Exchange (Like-Kind Exchange): To continue growing your real estate portfolio and increase investment power without immediate taxation, consider a 1031 Exchange. This strategy allows you to defer capital gains tax by selling an investment property and reinvesting the proceeds into another ‘like-kind’ property within specific timeframes.

• Installment Sale: To create recurring cash flow and reduce your overall tax rate by spreading out tax liability, an Installment Sale allows the buyer to pay you in installments over multiple tax years. This method defers capital gains, so you’re taxed proportionately as you receive each payment, potentially keeping you in lower tax brackets and paying less tax overall.

• Step-Up in Basis Upon Inheritance: To ensure your heirs can sell highly appreciated property without a large capital gains tax burden, consider holding it until you pass. Upon inheritance, your heirs receive a ‘step-up in basis’ to the property’s fair market value, effectively eliminating the capital gains that accrued during your lifetime.

• Tax Loss Harvesting: To reduce your current year’s taxable income and overall tax bill, you can utilize Tax Loss Harvesting. This involves strategically selling other investments that have lost value to generate capital losses, which can then offset capital gains from your real estate sale.

• Charitable Remainder Trust (CRT): To achieve significant philanthropic goals, convert an illiquid asset into income, and defer capital gains, a Charitable Remainder Trust (CRT) is an option. You donate highly appreciated real estate to the trust, which sells it tax-free, then pays you an income stream for a set period or life, with the remainder going to charity.

• Gifting Property: To transfer wealth and assets to heirs during your lifetime and potentially reduce your taxable estate, you might consider gifting the property. However, be aware that the recipient typically inherits your original cost basis, meaning they will be responsible for capital gains based on your purchase price if they eventually sell, shifting rather than avoiding the tax burden.

For a comprehensive guide on these and other powerful strategies to minimize your capital gains tax, explore our in-depth article: How to Avoid Capital Gains Tax on Land Sale.

By using these strategies and understanding how capital gains tax rules work, you’ll be in a stronger position to keep more of your profits.

Conclusion

Understanding how Alabama handles capital gains on real estate is crucial to keeping more of the gains from the sale. From knowing the federal and state tax rates, to exclusion and exemption rules, to calculating taxes on land sales or investment properties, it pays to be informed. Ultimately, by staying ahead of these tax implications, you can make smarter decisions and get the most out of your property sale in Alabama.

Please consult your financial advisor, accountant, real estate attorney, or tax professional. This article is for informational purposes and is not tax or legal advice.