Real Estate Tax Calc
Why Montgomery attracts real estate investors
Montgomery is Alabama’s capital city and home to approximately 200,000 residents, anchored by state government employment, Maxwell-Gunter Air Force Base, major healthcare systems, and Alabama State University. These employers create consistent demand for rental housing across a range of price points. Median home prices in Montgomery have historically tracked well below national averages, enabling investors to purchase rental properties at prices that generate meaningful gross yields.
From a tax perspective, Montgomery sits inside one of the most investor-friendly property tax environments in the United States. Alabama’s constitutional limits on property assessment — combined with historically low millage rates — produce effective property tax rates on investment residential property that are a fraction of what investors pay in Illinois, New Jersey, or Texas. The tradeoff is Alabama’s 5% state income tax, which applies to net rental income and to capital gains at the same ordinary income rate.
This guide explains the Alabama and Montgomery-specific tax rules that every investor should understand before buying: the property tax assessment system, income tax on rental income, depreciation and Schedule E deductions, capital gains treatment, 1031 exchange eligibility, and common mistakes.
Alabama’s fractional property tax assessment system
Alabama uses a fractional assessment system in which properties are assessed at a percentage of their market value, and the millage rate is applied to that assessed value — not the full market value. The percentage depends on the property’s classification under Alabama Code §40-8-1:
- Class I — Utility property: 30% of fair market value
- Class II — All property not Class I, III, or IV (includes non-owner-occupied residential investment property): 20% of fair market value
- Class III — Agricultural/forest: 10% of current use value
- Class IV — Owner-occupied residential (principal residence with homestead exemption): 10% of fair market value
Investment residential property (single-family rentals, duplexes, small multifamily) falls under Class II at 20% of fair market value in Alabama. Note that this is the general rule — owner-occupied principal residences qualify for Class IV at 10%, which is why the effective rate for investment property is higher than for homeowners. When modeling Montgomery investment property returns, use 20% as the assessment ratio unless you confirm with the Montgomery County Revenue Commissioner’s office that a specific property has been granted a different classification.
Montgomery County property tax rates
The total millage rate applied to a Montgomery investment property depends on the property’s location within the county — specifically, whether it falls within the Montgomery city limits or in an unincorporated area, and which school district applies. Montgomery County levies include state, county, school, and municipal components. Total millage rates for properties within the City of Montgomery typically range from approximately 48 to 58 mills depending on the applicable school district levy, though you should verify the current rate for a specific parcel with the Revenue Commissioner.
To calculate annual property tax: multiply the market value by 20% (Class II assessment ratio) to get assessed value, then multiply assessed value by the total millage rate and divide by 1,000. For a $200,000 investment property subject to 50 mills: $200,000 × 20% = $40,000 assessed value; $40,000 × 50/1,000 = $2,000 annual property tax. The effective rate relative to market value is $2,000 / $200,000 = 1.0% — which is moderate, though low compared to states like Illinois or New Jersey where effective rates commonly exceed 2%.
Homestead-exempt owner-occupied properties in the same area would be assessed at 10% of market value, producing a much lower bill. Investment properties do not qualify for the homestead exemption and are taxed at the higher 20% assessment ratio. This distinction is important when comparing Montgomery property tax rates to figures cited for the county generally — those averages often include the large number of homestead-exempt primary residences, which have lower effective rates.
Alabama income tax on rental income
Alabama taxes net rental income at a flat 5% state income tax rate. Net rental income is computed the same way for Alabama as for federal purposes: gross rents minus all ordinary and necessary rental expenses. Alabama conforms broadly to federal definitions of deductible rental expenses, including:
- Mortgage interest (deductible in full on rental properties under IRC §163, unlike the limited deduction for primary residences)
- Property taxes (deductible in full on Schedule E, not subject to the $10,000 SALT cap for rental properties)
- Depreciation (27.5 years for residential rental property under MACRS)
- Insurance premiums
- Repairs and maintenance
- Property management fees
- Advertising and leasing expenses
- Professional fees (accounting, legal) related to the rental
- Travel expenses for property management, with documentation
Alabama does not impose a separate net investment income tax (that is a federal 3.8% NIIT that applies at the federal level for high earners). The Alabama tax on rental income is simply 5% of net rental income after all allowable deductions.
Depreciation and its effect on taxable income
Federal depreciation rules under IRC §168 (MACRS) apply for Alabama income tax purposes. Residential rental buildings are depreciated over 27.5 years using the straight-line method under the general depreciation system (GDS). Land is not depreciable. Only the building and improvements portion of the purchase price generates depreciation deductions.
For a $200,000 Montgomery investment property where $160,000 is allocable to the building (80%) and $40,000 to land, the annual depreciation deduction is $160,000 / 27.5 = $5,818 per year. This is a non-cash deduction that reduces taxable income dollar-for-dollar, saving approximately $1,164/year in federal tax (at 20% effective rate) plus $291/year in Alabama income tax. Over 10 years, the accumulated depreciation deduction totals $58,180.
Alabama generally conforms to federal depreciation treatment, including the 27.5-year MACRS schedule for residential rental property. Unlike California, Alabama does not require investors to add back federal bonus depreciation on the state return; Alabama follows federal treatment for Section 179 and bonus depreciation. However, because residential rental property is not eligible for bonus depreciation (bonus depreciation applies to 5, 7, and 15-year property identified through cost segregation), this conformity has limited practical impact for most residential rental investors without a cost segregation study.
Capital gains when selling Montgomery investment property
Alabama does not provide a preferential capital gains tax rate. All capital gains — whether short-term or long-term — are taxed as ordinary income at the flat 5% Alabama income tax rate. This is one of Alabama’s significant disadvantages for long-term real estate investors compared to states like Tennessee or Washington that have no income tax, or compared to the federal treatment where long-term gains are taxed at 0%, 15%, or 20%.
When a Montgomery investment property is sold, the Alabama taxable gain is calculated the same way as for federal: sale price minus selling costs minus adjusted basis (original purchase price plus improvements minus accumulated depreciation). Depreciation recapture is also taxed at the 5% ordinary income rate for Alabama purposes, just as it is taxed at up to 25% for federal purposes (under the unrecaptured Section 1250 gain rules).
Worked example: after-tax return on a Montgomery rental
Consider a $200,000 single-family rental in Montgomery. The property rents for $1,500 per month ($18,000 per year gross). Annual operating expenses total $6,000 (property tax $2,000, insurance $1,200, maintenance $1,500, property management $1,300). Annual depreciation: ($200,000 × 80%) / 27.5 = $5,818. Annual mortgage interest (30-year, $160,000 loan at 7%): approximately $11,100 in year one.
Federal Schedule E income: $18,000 gross − $6,000 expenses − $11,100 interest − $5,818 depreciation = -$4,918 loss for tax purposes. If you qualify as an active participant in rental activities with AGI under $100,000, you can deduct up to $25,000 of this loss against other income under the special allowance (IRC §469(i)). The federal tax saving at 22% would be $4,918 × 22% = approximately $1,082. Alabama would also reflect the loss, saving approximately $246 in Alabama income tax.
Before financing, the property generates $12,000 per year in net operating income ($18,000 minus $6,000 in operating expenses). Cash-on-cash return on a $40,000 down payment (20%) after a $160,000 mortgage: annual debt service approximately $12,768; cash flow is -$768/year before tax. After tax savings, the effective after-tax return improves materially due to depreciation creating a deductible paper loss.
1031 exchange for Montgomery investment property
Alabama conforms to the federal 1031 like-kind exchange rules. A properly structured 1031 exchange allows a Montgomery investor to sell a rental property and defer both federal and Alabama capital gains taxes by reinvesting in a qualifying replacement property. Key federal rules that also apply for Alabama: the replacement property must be identified within 45 days of the sale closing, and the exchange must be completed within 180 days. The exchange must be handled through a qualified intermediary — the investor cannot receive the sale proceeds directly.
Alabama does not impose a clawback rule for exchanging into out-of-state replacement property, unlike California which requires ongoing reporting (FTB Form 3840) when a California property is exchanged for an out-of-state replacement. An Alabama investor can exchange a Montgomery property for a rental in Tennessee, Texas, or any other state, deferring the Alabama gain indefinitely. The gain is recognized only when the investor eventually sells the replacement property in a taxable transaction.
Alabama deed recording tax and closing costs
Alabama does not impose a broad real estate transfer tax. However, two recording-related taxes apply at closing. The deed recording tax is $0.50 per $500 of value (or fraction thereof) — for a $200,000 purchase, this is $200. The mortgage recording tax is $0.15 per $100 of the mortgage amount — for a $160,000 mortgage, this is $240. Both amounts are paid at closing. These costs are not deducted immediately; they are added to your cost basis in the property.
Other closing costs — title insurance, attorney fees, lender fees, appraisal — are similarly added to basis and recovered through depreciation over 27.5 years rather than deducted in the year of purchase. Points paid to obtain a mortgage are deducted ratably over the life of the loan (not all in year one for a rental property, unlike for a primary residence).
Common mistakes Montgomery investors make
Using the wrong assessment ratio. As noted above, investment properties are assessed at 20% of market value, not 10%. Using the 10% ratio underestimates property tax cost by 50% and produces inflated underwriting.
Ignoring Alabama income tax in return projections. At 5% of net income, Alabama income tax is not trivial. A property generating $10,000 in net rental income produces a $500 Alabama state tax bill annually. Factor this into your after-tax return calculations.
Failing to segregate land and building at purchase. The land portion of a property is not depreciable. Investors who fail to properly allocate purchase price between land and building — or who use an inflated land allocation that understates building basis — leave depreciation deductions on the table. Obtain an appraisal or use county assessor land/improvement breakdowns to support your allocation.
Overlooking the passive activity loss rules. The $25,000 special allowance for rental losses begins to phase out at $100,000 of modified AGI and is fully phased out at $150,000 of MAGI. High-income investors who cannot use rental losses currently may need to track suspended losses until the property is sold or until Real Estate Professional Status qualifies them to deduct the losses in full.
Frequently asked questions
Does Alabama tax rental income?
Yes. Alabama taxes net rental income at a flat 5% state income tax rate. Net rental income is reported on Alabama Schedule E (or Schedule C for properties treated as a business). All ordinary and necessary rental expenses, including depreciation, mortgage interest, insurance, repairs, and property management fees, are deductible in computing net taxable rental income.
What is the property tax rate in Montgomery County, Alabama?
Montgomery County property taxes are among the lowest in the country in effective rate terms. Alabama law requires investment residential property (Class II) to be assessed at 20% of fair market value. The applicable millage rate is then applied to that assessed value. Total effective rates for investment property in Montgomery typically run between 0.8% and 1.1% of market value depending on the specific municipality and applicable levies. Always verify the current millage with the Montgomery County Revenue Commissioner before purchase.
How are capital gains taxed in Alabama?
Alabama does not have a preferential capital gains tax rate. Gains from the sale of investment real estate are taxed as ordinary income at the flat 5% Alabama income tax rate. This applies to both short-term and long-term gains. Federal capital gains rates (0%, 15%, or 20% depending on income and holding period) apply on your federal return separately. Alabama depreciation recapture is also taxed at the same 5% ordinary income rate.
Can I use a 1031 exchange to defer Alabama taxes when selling Montgomery investment property?
Yes. Alabama conforms to the federal 1031 like-kind exchange rules under IRC §1031. A qualifying 1031 exchange defers both federal and Alabama capital gains tax. Alabama does not impose a separate clawback rule like California does, so exchanging into out-of-state replacement property defers the Alabama gain indefinitely until a taxable sale occurs. However, Alabama depreciation recapture deferred via 1031 will be recognized upon the eventual taxable disposition.
Is there a transfer tax when buying investment property in Alabama?
Alabama does not impose a traditional real estate transfer tax. However, a deed recording tax applies at $0.50 per $500 of the property value (or fraction thereof), paid at closing. For a $200,000 purchase, this amounts to $200. There is also a mortgage recording tax of $0.15 per $100 of the mortgage amount. These amounts are added to your cost basis, not deducted immediately.
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.