USA: Regional Real Estate 2018 Comparisons

Last Updated June 08, 2018

Contributed By Sirote & Permutt PC

Law and Practice

Authors



Sirote & Permutt PC 's attorneys in our Real Estate Practice Area are adept at handling the myriad needs of real estate developers and investors, including assisting our clients in procuring capital and credit, often combining construction, permanent, mezzanine, and tax credit facilities with equity participations. We also handle zoning and other land-use matters, as well as litigation and controversies, including eminent domain, design and construction, environmental regulatory enforcement, ejectments and dealing with insolvent counterparties. Additional contributors: Donald Johnson, Peter Hardin, Samuel Friedman and R Ryan Daugherty.

Knowledge of federal (such as tax and environmental), state and local law, and the changes to those laws, as well as local forms and customs are essential in successfully practising real estate law in Alabama. Land records in Alabama are handled on a county-by-county basis. In addition to the law, a good practitioner knows how each county office (ie, each Probate Office) interprets the law. Many Probate Offices are implementing new technological improvements to improve filing, record-keeping, and access to recorded documents, but these developments can vary significantly between different counties. Because successful transactions often involve extensive negotiations, understanding the goals of each side also helps bridge the differences between the parties to successfully reach agreement on terms. Closing commercial deals now involves many “standard” forms and requirements both for state law compliance and title insurance. Being knowledgeable about these methods and procedures and the law, along with constructive negotiating skills, is more likely to create stable, efficient and successful transactions.

In the past 12 months, one of the most signification trends in Alabama real estate market has been the re-purposing of buildings and facilities. With the change in usage and re-purposing of various types of real estate, it is essential to understand each type of real estate conveyance and the applicable leasing and zoning laws to create a seamless way to assist clients with their redevelopment needs. Recent examples of projects re-purposing real estate in Alabama involve turning old hospital space into new office/retail uses, as well as redevelopment of vacant retail space into entertainment or data centre usage. Alabama has seen significant development over the past year with the location of a completed TopGolf in Birmingham, and the location of the Toyota/Mazda plant in the northern part of the state in Madison and Limestone counties, providing an expansion of Alabama’s already developed automobile industry and a boom to the economy of North Alabama.

In general, Alabama’s income tax law incorporates the recent federal income tax law changes. For example, C corporations conducting business in Alabama use the federal taxable income as the base for computing Alabama income taxes. See Ala. Code 1975 §40-18-33. For taxpayers other than C corporations, most (but not all) of the federal tax provisions affected by the recent federal tax reform legislation are also incorporated by reference into Alabama’s income tax system.

Many commercial transactions utilise a single-purpose and single-asset limited liability company. The member(s) of such single-purpose entities often include joint ventures, limited partnerships, or other LLCs formed for the particular real estate investment opportunity, but many lenders require that fee title to the underlying commercial real estate be held by a newly formed, single-purpose LLC.

A conveyance of real property generally must be written and signed by all parties with witnesses to the signatures (Ala. Code 1975 §35-4-20), and contain a valid description of the property. Conveyance instruments must provide the name and address of the preparer of the instrument, §34-4-110, list the marital status of the grantor and homestead status of the property being conveyed, §34-4-73, and provide ad valorem tax notice (typically in the form of the Real Estate Sales Validation Form RT-1), §40-22-1. Residential conveyances do require some special disclosures, but generally there are not special laws regarding the transfer of real property based on the use. However, the parties to a transaction or locality rules may require additional provisions (eg, waivers of claims, restrictions on use, easements, reservations, etc) be included in the deed or in a separate document recorded with the deed at closing.

Transfer of title is generally effectuated by a deed, usually taking the form of a general warranty deed, statutory warranty deed (pursuant to Ala. Code 1975 §35-4-271), or a quitclaim deed. In commercial transactions, the most common form of deed is the statutory warranty deed. Other forms of conveyancing and/or transfer or occupancy instruments include ground leases, leases, judicial decrees vesting title to real property, foreclosure deeds, tax deeds, sheriff's deeds, and deeds in lieu of foreclosure. Conveyancing instruments must be recorded in the office of the judge of probate for the county in which the property resides (Ala. Code 1975 §35-4-50). Alabama uses a hybrid "race-notice" system where a purchaser takes priority over all prior purchasers of which he has no notice at the time he records his conveyance – eg, Nelson v Barnett Recovery Corp., 652 So. 2d 279, 280 (Ala. Civ. App. 1994).

In commercial transactions, due diligence is typically carried out prior to closing and involves a review of title and survey matters, physical inspection of the property, inspection of financial and other records pertaining to the property, review of relevant zoning, permitting, or platting (mapping) requirements, and may include examination of the environmental condition of the property. Lawyers are typically assigned review and/or cure of title and survey matters, and are often involved in addressing permitting and platting requirements and resolution of environmental matters (if applicable).

Purchase and Sale Agreements ("PSAs") may vary from those providing for the sale of property in its "as-is, where-is" condition with no representations, to PSAs containing significant representations and warranties such as the following:

  • seller's ownership of title to the property;
  • seller's authority to sell the property;
  • no violations of law are present on the property;
  • no tenants in possession of the property (except as noted);
  • seller's warranty to satisfy any mechanic's liens;
  • environmental matters;
  • zoning and permitting status;
  • absence of pending litigation and condemnation.

Alabama law provides for an implied warranty of fitness and habitability for the sale of new residential property, but the doctrine of caveat emptor generally applies – Sims v Lewis, 374 So. 2d 298, 303 (Ala. 1979).

A buyer's remedies for a seller misrepresentation are based on the terms of the contract, and the seller's liability for such a breach can be negotiated and is often capped at a specific dollar amount, varying based upon the underlying transaction.

Firstly, foreign companies are not required to register with the state unless such entity is considered to be transacting business in Alabama (Ala. Code 1975 §10A-1-7.01). Foreign companies must, however, comply with all federal laws relating to transfer of property to a foreign investor, including FIRPTA, etc.

Secondly, foreign investors should also consider the tax implications of such a transaction when purchasing real estate. (See section 8 Tax below for more detail.)

Alabama's laws generally conform to federal laws with regard to environmental matters. Because environmental statutes often hold the current owner strictly liable for costs of remediation, commercial real estate buyers and sellers often allocate environmental liability contractually between the parties. A buyer and seller will negotiate the terms of any "as-is" language in the contract, indemnification for environmental matters, and any release of environmental claims between the parties, all on a contractual basis. The negotiated terms vary between contracts, with sellers favouring caps on their liability, and buyers preferring a complete indemnification from sellers.

An interested buyer can request a zoning verification letter (with a copy of the code) from the planning department of the applicable jurisdiction. Some departments will include statements of compliance or non-compliance, but many counties in Alabama do not have the staff capacity to do so. In those cases, if a buyer or its lender requires a compliance certificate, there are consultants available that will provide such a compliance report or certificate for a fee. Local municipalities may enter into a development agreement to facilitate a specific project use, depending on the type of project and the local municipality.

In Alabama, governmental taking of property by eminent domain and condemnation actions may occur if the property is taken for a "public use" and payment of "just compensation" is made for such property (Ala. Const., §235). In addition to state and federal constitutional limitations, Alabama has adopted the Alabama Eminent Domain Code that sets procedures for eminent domain cases. (Ala. Code 1975 §18-1A-1, et seq). If a landowner rejects an offer to purchase from the state, the state will file a complaint for condemnation with the probate court for the county where the relevant property is located.

The deed tax is triggered by any conveyance of real estate, and is typically allocated to the purchaser unless otherwise agreed to by the parties. The purchase of an interest in a property-owning company is not considered a conveyance of real estate, and therefore does not trigger the deed tax. The deed tax is USD0.50 for every USD500 (rounded up) of value of the property conveyed. If a mortgage is recorded simultaneously with the deed, a credit is provided by statute, such that the deed tax due is calculated on the value of the real property not securing the mortgage only (Ala. Code 1975 §40-22-1(c)). For example, if a property is purchased and sold for USD2 million and the deed is recorded simultaneously with a mortgage of USD1.5 million secured by the property, the deed tax would be calculated only against the USD500,000 portion of the property's value not already subject to the mortgage tax. Statutory deed tax exemptions exist for certain instruments made for agricultural purposes (Ala. Code 1975 §40-22-4), farm loans (Ala. Code 1975 §40-22-5), and conveyances by religious organizations (Ala. Code 1975 §40-22-5.1).

Under Alabama law (in addition to FIRPTA), upon the sale of any real property, the transferor must withhold 3% (if the buyer is an individual) or 4% (if the buyer is an entity) of the purchase price or, if the gain recognized on the sale is less than the purchase price and the seller provides the buyer with an Affidavit of Seller's Gain (see Alabama Department of Revenue Form NR-AF2), the buyer may withhold 3% or 4% of the amount of the gain (Ala. Code 1975 §40-18-86). Transferors may be exempt from the foregoing withholding requirements under Ala. Code 1975 §40-18-86(b). See section 8 Tax below for more detail.

In Alabama, acquisition of commercial real estate is generally financed with indebtedness secured by a mortgage lien on the property being acquired. Depending on the type of real estate, financing may be available through bank debt, conduit loans or government-sponsored enterprises such as Federal National Mortgage Association (Fannie Mae) or Federal Home Loan Mortgage Corporation (Freddie Mac).

In Alabama, a purchaser or developer of commercial real estate generally grants a mortgage to secure borrowed funds used to acquire and/or develop the real estate. Most commercial lenders also incorporate a security agreement into the mortgage (in addition to separate UCC filings made locally and in the domicile state of the borrower entity) to cover personal property attached to or used in connection with the mortgaged real estate and proceeds. Lenders can also collateralize (with additional agreements and filings) the borrower's entity interests or stock and/or deposit accounts.

Based on the facts and circumstances of the particular financial institution’s activity in Alabama, financial institutions that are not domiciled in Alabama may be required to qualify to do business in Alabama and liable for filing tax returns and payment of annual privilege tax (under Alabama Code 1975 §§ 40-14A 21 to 40-14A-29) and excise tax (under Alabama Code 1975 §§ 40-16-1 to 40-16-8) if the financial institution is doing business in Alabama within the meaning of the laws.

Under Alabama Code 1975 §40-22-2, mortgage recording tax is generally USD0.15 per USD100 of the loan amount secured by the mortgage. Mortgages with open-end or revolving indebtedness have two options for paying the recording tax: (i) if the mortgage does not state the maximum principal indebtedness, the taxpayer must pay a recording tax on the actual amount initially advanced and annually report the amount of indebtedness secured by the mortgage and pay tax on any additional advances made; or (ii) the more common approach is to pay the recording tax based on the maximum principal indebtedness stated in the mortgage, regardless of the cumulative amount actually advanced. There are mechanisms such as obtaining tax orders from the Alabama Department of Revenue for allocating recording tax for mortgages covering property in multiple counties or states. Additionally, a nominal per-page recording fee will be collected at the time of recording.

Other than general principles of contract law and granting a mortgage in proper form for recording with the required information included in the document (such as proper execution, witness or notary acknowledgement, and a proper description of the collateral), there are no specific legal rules or requirements. On most transactions, it is recommended to obtain a lender’s title insurance policy insuring the mortgage.

In Alabama, a mortgage must be recorded to maintain priority over subsequent liens granted on the property. Alabama Code 1975 §35-10-1, et seq deals with the requirements for foreclosure in Alabama. Also, note there is a homestead exemption pursuant to Alabama Code 1975 §6-10-2 and a one-year statutory right of redemption under Alabama Code 1975 §6-5-248(b).

Existing secured debt can be subordinated to newly created debt if the parties execute and record a subordination agreement.

Unless the lender is deemed to be a "partner" in the transaction, a lender cannot be held liable under environmental laws (state or federal) for merely holding security (ie, a mortgage) on real property, unless it directly causes the pollution or contamination. Nonetheless, most lenders in Alabama typically require an environmental indemnity agreement from the borrower and one or more beneficial owners.

If, however, the lender forecloses and becomes the property owner, the only way to qualify for liability exemptions under the Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”) for existing contamination is to timely conduct all appropriate inquiry (“AAI”) according to the ASTM E1527-13 standards prior to the date the loan is made. AAI investigations must be conducted no more than one year prior to closing of the loan. Any report more than one year old is of no value in establishing an innocent purchaser defence under CERCLA. In addition, certain portions of the AAI investigation are only good for 180 days. Consequently, any AAI report more than 180 days old should be updated prior to closing of the loan. If AAI is not performed or is not performed in a timely manner, then a lender can be liable once it takes possession of the property for contamination the lender did not cause.

In addition to AAI, most mortgage lenders in Alabama require the borrower (and other indemnitors) to agree to indemnify the lender against potential environmental liability. This is typically accomplished either in the mortgage or in a separate environmental indemnity agreement.

Lenders should consider general principles of US federal bankruptcy law. Typically, loan documents will include provisions dealing with bankruptcy of the borrower (eg, making it a default under the mortgage if the borrower or a related party is subject to bankruptcy proceedings, but such provisions are of limited or no value in a bankruptcy proceeding).

When a borrower files a bankruptcy petition, an automatic stay of all actions against a borrower’s property, including foreclosure, comes into existence. If a security interest is foreclosed prior to the bankruptcy filing, then, in the absence of some defect in the foreclosure process, the foreclosed property does not become part of the borrower’s bankruptcy estate and the lender is free to exercise its state law rights as to the property, including taking possession. Even in that scenario, a lender may be forced to ask the bankruptcy court for permission via a motion for relief from the automatic stay to oust a borrower who remains in possession of the property. In addition, the foreclosing lender may have an unsecured claim (a deficiency claim) to assert against the borrower in bankruptcy.

Alternatively, if a secured lender fails to foreclose its lien prior to a borrower’s bankruptcy filing, the lender will be forced to participate and assert its rights in the borrower’s bankruptcy case. Typically, a lender will file a proof of claim and, depending on which bankruptcy chapter the borrower files under – eg, Chapter 7 (liquidation), or Chapter 11 or 13 (business or consumer reorganisation) – will participate in the confirmation process as to the borrower’s proposed plan of reorganization. While in bankruptcy, the lender may assert the rights granted to it under the relevant loan documents; however, those rights are tempered by the Bankruptcy Code. Prior to taking many actions that would otherwise be allowed outside of bankruptcy, a lender must petition the court for relief from the automatic stay. In addition, as to non-residential property not a borrower’s homestead, a lender’s secured lien can be “valued” – ie, bifurcated into secured and unsecured portions after a valuation hearing with the bankruptcy court. Likewise, a wholly unsecured junior lien may be “stripped off” the property and treated as completely unsecured in certain circumstances.

Outside of bankruptcy, a borrower’s insolvency will ordinarily lead to a default under the terms of the relevant loan documents and subsequent foreclosure of the secured collateral. In the commercial context, and depending on the size and characteristics of the commercial loan and property, a borrower’s insolvency might lead to a receiver being appointed under Alabama law; see Ala. Code 1975 §6-6-620 et seq.

Local municipal corporations (cities and towns) may enact zoning laws and regulations through the creation of a comprehensive zoning ordinance, which must be compatible with the enabling statute (Ala. Code 1975 §11-52-1 et seq). Zoning laws generally designate areas into business, industrial, and residential districts and control the type, character, kind, and use of structures and improvements in such designated zones or districts (Ala. Code 1975 §11-52-70). County governments may also enact zoning ordinances and building codes for flood-prone areas outside of municipalities (Ala. Code 1975 §11-19-3).

Private restrictive covenants in the property's chain of title may also create similar controls on the development of property or refurbishment of an existing building. These will be reviewed and assessed during the due diligence period.

Local zoning laws are passed by the local municipal planning commission and must be consistent with the local comprehensive plan, in accordance with Ala. Code 1975 §11-52-3. Zoning laws typically control the permitted shape, proportion and dimensions of lots and structures located thereon, use of such structures, setback requirements, as well as the use of parcels in designated zones or areas.

For certain redevelopments (such as brownfield developments) the Alabama Department of Environmental Management may have recorded certain restrictions on use, development, etc, into the chain of title of a property.

Developers typically begin by engaging certain consultants like architects and civil engineers and begin contacting the local planning department for guidance on the permitting process, as some municipalities advise developers to hold a pre-application review meeting to streamline applications. Developers should first review the applicable zoning laws for the project and obtain approval from the local zoning official/department before moving forward to apply for a building permit. Depending on the size and complexity of the project, a developer may be required to obtain approval from the municipality's planning, zoning, engineering, traffic engineering, inspection, water pollution control, natural resources, or legal departments (among others) before obtaining building permits. If a project requires a change to the zoning code, vacation of road, etc, public hearings are held (often requiring notice be given to neighbouring property owners) and third parties are permitted to comment and object during such public hearings. Local non-attorney professionals (civil engineers, etc) may be able to provide guidance on local customs to help navigate this process.

The process of appealing a decision regarding an application for permission to develop a property will vary based on the project and jurisdiction, and interested parties should consult the relevant state and local laws.

The process of obtaining permits and approvals varies among different local governmental authorities and utility companies (for larger projects). Planned unit developments are sometimes used or required by a local government to facilitate development of a project. Interested parties should consult the relevant local authority for further details.

For governmental restrictions on development and use of property, the first enforcement mechanism to restrict development or designated use of a specific property is for a local planning department to refuse to issue a building permit. After issuance of a building permit, restrictions on development or designated use are enforced by an inspector named by the designated zoning official/administrator. The zoning official/administrator is generally authorized to appoint inspectors and seek assistance from other municipal departments to determine if a violation has occurred.

Private parties may also place restrictions on the development or use of real property by creation of a restrictive covenant that runs with the land. The Alabama Supreme Court has recognised that "[a] covenant is an agreement or promise of two or more parties that something is done, will be done, or will not be done. In modern usage, the term covenant generally describes promises relating to real property that are created in conveyances or other instruments”; Collins v Rodgers, 938 So. 2d 379, 385 (Ala. 2006). In the real property context, restrictive covenants are generally memorialized by (i) restrictive language in a conveyance instrument, (iii) an express Declaration of Covenants, Conditions, and Restrictions created by a single property owner, or (iii) an Agreement for Covenants, Conditions, and Restrictions agreed to by two or more property owners, all of which may be recorded in the probate office of the county of the encumbered property. Such private restrictive covenants may be enforced by the parties to the covenant or the successor in title to such a party. However, Alabama does follow a "general rule that restrictive covenants are not favored in the law and, therefore, that they will be strictly construed, with all doubts resolved in favor of the free and unrestricted use of land and against the covenants"; Whaley v Harrison, 624 So. 2d 516, 518 (Ala. 1993). To evaluate a specific restrictive covenant, a local attorney should be consulted.

Alabama law authorises the formation of corporations, general partnerships (“GPs”), limited partnerships (“LPs”), limited liability companies (“LLCs”), and real estate investment trusts ("REITs") for the purpose of holding real estate.

The most frequently used ownership entities in Alabama are LPs and LLCs. Generally, LLCs are preferred to LPs as investment vehicles because none of an LLC’s owners (known as “members”) is liable for the debts and obligations of the entity, while an LP is required to have at least one partner (known as the “general partner”), who is liable for such debts and obligations. LLCs also have a potential tax basis advantage over LPs in qualifying for non-recourse basis treatment for an entity-recourse debt. Alternatively, an LP may be preferable if certain owners are not US citizens and the requirements of their home country’s tax laws would impose additional tax burdens upon them otherwise.

Both LPs and LLCs are usually preferred over corporations (other than REITs, as described below) because corporate income is taxed at the corporate level, and then the dividends paid to the corporate owners (“shareholders”) are taxed again. A corporation’s shareholders can elect to make an S-election, becoming known as an S-corporation (“S-corp”), and be taxed as a partnership and have income and losses “passed-through” and taxed only at the owners’ level. LPs and LLCs, unless the owners elect to be taxed as a corporation, are not taxed at the federal level, and all of their income is “passed-through” and taxed only at the owners’ level. LLCs have a further advantage over S-corps in that they:

  • do not suffer the same limitations as S-corps on the pass-through of losses;
  • are not restricted in who can own the entity like S-corps (S-corp owners must all be US citizens or residents, must be individuals or certain types of trusts, and must not exceed 100 in number);
  • can have any number of classes of equity to divide income and losses among the owners; and
  • are taxable generally as partnerships with flexibility on allocations of profits and losses and distributions of cash.

Corporations that own real estate often do so in connection with their trade or business (eg, factories).

Other entity types can be used to hold real estate assets as well, such as S-corporations and general partnerships, but their use is infrequent due to taxation and liability concerns, respectively. REITs are corporations or business trusts that elect REIT status, allowing them to pass-through income to their owners, like LPs and LLCs; however, because of the complex qualifications required of REITs under the US tax code, investments in REITs are normally limited to large income-producing assets or portfolios of assets. Many REITs are formed as Maryland corporations.

With respect to LPs and LLCs, almost all features of their operations are negotiated among the partners or members in an LP’s limited partnership agreement or in an LLC’s limited liability company agreement, including how and by whom decisions are made and how the economics are divided. Major decisions typically require the consent of the partners or members and often include:

  • a sale or refinancing of the principal asset;
  • certain major leases;
  • construction matters, such as budgets and hiring of contractors; and
  • decisions affecting the continuation of the entity, such as merger and consolidation, termination and bankruptcy.

These agreements also establish the priorities of economic distributions and payment of agreed-upon fees among the partners or members and provide how and when additional capital may be called from the partners or members. It is important that these agreements properly address income tax considerations, because the allocation of economic benefits and tax liabilities of ownership must comply with detailed regulations under the US tax code or risk having unintended tax outcomes. Finally, both types of agreements will generally have provisions allowing for certain owners to buy the interests of other owners, or to have the assets sold under certain circumstances.

Many activities of corporations, including REITs, are governed by Alabama corporate statutes and judicial decisions. In closely held corporations, the owners (shareholders) may enter into a shareholders' agreement which establishes, among other things, how votes are cast and how interests in the corporation may be bought and sold or otherwise transferred. Economic distributions within corporations are generally less flexible than distributions within LPs and LLCs. Each share in the same class of ownership shares is entitled to the identical economic distribution as each other share in that class. In order to allocate economics in a corporation differently among shareholders, multiple classes of shares must be created with different priorities of payments and claims on a corporation’s distributions.

If an entity is a pass-through entity for federal income tax purposes it also will be a pass-through entity for state income tax purposes in Alabama, but it will need to file an appropriate state tax form to facilitate direct taxation of the owners of the entity. For corporations, Alabama imposes an income tax but does not separately tax REITs. 

The mere ownership of real estate in Alabama does not require the entity to qualify or register to do business in Alabama, but that is a limited exception and generally applies to the ownership of undeveloped land. Common attributes of active ownership, such as development and leasing of real estate in Alabama, require an entity organised elsewhere to qualify to do business in Alabama. An annual business privilege tax is levied in Alabama for the privilege of being organised under the laws of Alabama or doing business in Alabama. The privilege tax is reported to the Alabama Department of Revenue on an annual report, which is a simple statement confirming addresses and basic information about the entity. The privilege tax is currently USD100 per year, and the initial tax return is due within two-and-a-half months of the initial formation, organisation or incorporation of the entity.

Accounting costs for non-tax state filings will not, as a rule, be significant as those filings typically do not contain significant financial information. On the other hand, tax filings and the accounting costs related to those filings will be more significant and will depend on the complexity of the particular company and the amount and nature of its assets and income.

The governance structure in LPs are set out in the agreement of limited partnership and require that most decisions be made by the general partner. Alabama law allows certain voting rights for the limited partners without jeopardising their status as limited partners; however, one of the reasons that limited partners do not have liability for the obligations of an LP is that they generally do not have control of the day-to-day activities of the partnership. 

In an LLC, there are two types of governance structures. One is the so called “member-managed” structure where the members are responsible for managing the limited liability company. How the members make decisions – by majority, super-majority or unanimous vote depending on the nature of the decision and the relative weight of each member’s vote – is set forth in the limited liability company agreement. The other type of LLC is a "manager-managed" limited liability company in which a person or entity (who may or may not be a member) is designated as the manager with decision-making rights as set forth in the limited liability company agreement. The members who are not managers often retain the right to consent to certain major decisions. A manager can be one person or several persons each having the ability to act independently or being required to act, similar to a board of directors of a corporation, by majority, super-majority or unanimous vote depending on the nature of the decision and the relative weight of each member’s vote as set forth in the limited liability company agreement.

For corporations, including REITs, governance is set forth in their articles of incorporation and their bylaws. The articles of incorporation is a filed, public document containing certain statutorily required information such as the name, registered office and registered address of the corporation. The bylaws govern how shareholders vote for the members of the board of directors, how the board elects officers, the duties of the officers, the frequency of shareholder meetings, the frequency of board of directors’ meetings and other routine matters. In most corporations, all day-to-day decisions are made by the officers without approval of owners who are not officers. Certain decisions outside the normal course of business will be made by the board of directors, again without input from owners who are not part of the board. Unless an owner is a director or officer, its only governance right is to periodically vote for members of the board, or in connection with certain statutorily required matters, such as merger transactions.

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The fee owner of real property may grant a leasehold estate or licence to permit others to occupy and use the owner's real property for a limited timeframe. Leasehold estates allowing a tenant to occupy and use real estate without buying it outright are generally categorized into: (i) a tenancy for years; (ii) a periodic tenancy; or (iii) tenancy at will or at sufferance.

A tenancy for years is a leasehold estate "limited to endure for a definite and ascertained period, fixed in advance"; Waldrop v Siebert, 237 So. 2d 493, 494 (1970). A periodic tenancy is one where the lease has no stated duration and periodic rent is reserved or paid; Gulf Coast Realty Co. v Prof'l Real Estate Partners, Inc., 926 So. 2d 992, 1007 (Ala. 2005). In Alabama, if no time for termination is stated, the law construes the term to be from December 1st to December 1st (Ala. Code 1975 §35-9-3). Finally, a tenancy at will or at sufferance is a lease "for an indefinite and uncertain term" and is sometimes called a tenancy from month to month; Melson v Cook, 545 So. 2d 796, 796 (Ala. Civ. App. 1989). If specified as a tenancy at will in the lease, this lease may be terminated by either party at will by ten days' notice in writing (Ala. Code 1975 §35-9-3).

There are no formal, legal distinctions between different types of commercial leases; however, commercial leases are generally divided between "net" leases and "gross" leases. In a net lease, a landlord charges its tenant a base rent plus additional rent for "pass-through" items like common area maintenance, insurance costs, advertising, etc, which pass-through items will vary based on the terms negotiated by the parties. In a gross lease, a landlord charges its tenant one flat fee for rent and the landlord is responsible for the costs of maintenance of the property; however, such maintenance costs are typically accounted for in the amount of the gross lease's base rent. Further, certain categories of commercial leases such as shopping centre leases or oil and gas leases often contain specialized terms that are unique to the subject matter involved.

There are no restrictions on the type or amount of rent charged under a commercial lease in Alabama. A lease term may not be longer than 99 years (Ala. Code 1975 §35-4-6). If any portion of a lease term is longer than 20 years, the lease or a lease memorandum must be recorded within one year of signing, or the portion of the term exceeding 20 years is invalid (Ala. Code 1975 §35-4-6).

Residential leases are generally more regulated than commercial leases, and are subject to the Uniform Residential Landlord and Tenant Act (Ala. Code 1975 §35-9A-101, et seq.) For example, under a residential lease, a landlord may not charge a tenant for certain fees – landlord's attorneys' fees, costs of collection, etc (Ala. Code 1975 §35-9A-163).

Lease terms range from less than one year up to 99 years, depending on the terms of a specific lease.

Landlords typically maintain structural components of leased real estate, while tenants are often required to maintain the leased premises and those systems and improvements serving the leased premises in good working order, though the extent of such maintenance responsibilities varies widely between different landlords and tenants.

Monthly rent payments are typical, but the parties may agree to different terms.

The rent payable may vary between different payment periods during the term, based on the terms of the lease, typically increasing as time passes during the term.

Changes and increases in rent will be determined by the terms negotiated by the parties in the lease. 

There is typically no governmental tax collected on rent paid to a landlord. However, transfer taxes are due when a lease (or memorandum of lease) is recorded in the public records in an amount equal to the tax consideration. Tax consideration = (term of lease in months) x (monthly rent) x (percentage from lease percentage chart)/1000.  The foregoing lease percentage chart is held by the probate court of the county where the property is located, is based on the term of the lease, and varies in amount from county to county. Tax consideration is rounded up to the nearest USD500 (Ala. Code 1975 §40-2-1(c)). Further, some municipalities charge revenue-based licence fees for entities doing business within the municipality, and the rental of property is a category of business that requires payment of such annual fees.

Costs paid by a tenant at the start of a lease vary by the transaction and negotiation of the parties. Tenants may pay for the first month's rent, a security deposit, broker's fees, or other landlord administrative fees at the start of a lease in addition to rent.

Net commercial leases often pass through operating expenses (including common area maintenance and repair) to the tenant, in accordance with the terms of the lease, typically prorated among the tenants of a specific property based on the amount of square footage leased by each tenant at said property. Gross commercial leases typically require that the landlord pay for the maintenance and repair of the common areas, though these costs are also typically priced into the rent paid by the tenant.

For a residential lease, the landlord is required to "keep all common areas of the premises in a clean and safe condition" along with other requirements for the working order and condition of the leased premises (Ala. Code 1975 §35-9A-204).

Net commercial leases often include utilities and telecommunications services serving an entire property (not just an individual tenant's leased premises) in the operating expenses that are charged to tenants on a pro-rata basis, while gross commercial leases may include the costs of such services, utilities and telecommunications in the rent charged to the tenant. If such utilities or services are separately metered and service only a single tenant's leased premises, that tenant is often responsible for payment of such services.

Payment of insurance premiums insuring the real estate that is subject to a lease is typically done by a landlord, but such costs are often passed through to tenants as an operating expense in net commercial leases. Insurance coverages vary by property, but many commercial landlords carry general liability, casualty, flood, and fire insurance, as well as coverage for bodily injury, property damage, lost rents, etc.

Landlords may limit the way commercial tenants use leased real estate, and often prohibit tenants from using the lease premises for certain exclusive uses negotiated with other parties. Applicable zoning laws and private restrictive covenants in the property's chain of title may impose further restrictions on tenant uses, though leases often require compliance with all applicable laws and restrictive covenants.

The terms of a lease will dictate whether or not a tenant is permitted to alter or add improvements to real estate during the lease. Often, tenants may receive a tenant improvement allowance to induce signing the lease, requiring that a landlord either install certain improvements on the premises or reimburse tenant for its costs related to the same. Often a lease may require a tenant to obtain the landlord's written approval for materials, plans, contractors, etc, involved for such improvements before starting construction or installation of any such improvements. Further, trade fixtures may generally be removed by a tenant, but if the tenant damages the underlying real property in the process of removal, the tenant may be held liable for damages to the property; LaFarge Bldg. Materials, Inc. v Stribling, 880 So.2d 415, 419 and 424 (Ala. 2003).

The Alabama Uniform Residential Landlord Tenant Act, Ala. Code 1975 §35-9A-101 et seq, governs any rental agreement ("all agreements, written or oral, and valid rules and regulations adopted under §35-9A-302 embodying the terms and conditions concerning the use and occupancy of a dwelling unit and premises") related to the rental of any dwelling unit (a "structure or the part of a structure, including a manufactured home, that is rented as a home, residence, or sleeping place by one or more persons") to a tenant ("a person entitled under a rental agreement to occupy a dwelling unit to the exclusion of others"); Ala. Code 1975 §§ 35-9A-141(13), (4), and (16). This statute includes additional rules and regulations for both landlords and tenants in the residential context. For the leasing of non-residential real estate, individual leases may include specific restrictions related to the category or use of the leased premises, but such leases are generally not subject to specific regulations or laws due to the use or category of the underlying leased premises.

Leases often contain language stating that a tenant's insolvency or the filing of any bankruptcy petition (voluntary or involuntary) constitutes a default under the lease. However, if the lease remained in force at the filing of a bankruptcy petition, the leasehold estate is considered an asset of the tenant, which is protected by the automatic stay of the Bankruptcy Code.

In addition to requiring a tenant to provide a security deposit under the lease, a lease may provide that a tenant grant the landlord a security interest in the furniture, fixtures, equipment, inventory, etc, located at or related to the leased premises. The landlord may file such a security agreement with all rights granted under the UCC or other applicable statutes. A landlord may also require the tenant deliver a letter of credit or personal guarantee for costs related to and default by a tenant under the lease. However, for residential leases, liens or security interests of a residential landlord in a tenant's household goods are not enforceable unless perfected before 1 January 2007 (Ala. Code 1975 §35-9A-425).

Commercial landlords are also granted statutory liens over crops grown on rented land (Ala. Code 1975 §35-9-30), and for goods, furniture, and effects of a tenant or subtenant for rent due (Ala. Code 1975 §35-9-60).

Generally, a tenant does not have the right to continue to occupy the leased premises after the expiry or termination of a commercial lease. When a tenancy is for a certain period of time and the term expires under the lease, the tenant is bound to surrender possession, without the landlord providing notice to quit or demand of possession (Ala. Code 1975 §35-9-8). If a landlord has terminated the lease for a breach or default, the landlord must give the tenant notice of termination at least ten days prior to terminating a commercial lease (unless the lease provides for additional time) and, after delivery of such notice, the landlord must demand the tenant surrender possession of the premises within ten days of receipt of the notice of demand (Ala. Code 1975 §35-9-6).

If the tenant does not deliver possession of the leased premises after demand as described above, the landlord may pursue an unlawful detainer action in the district court of the county where the premises is located (Ala. Code 1975, §6-6-330). The landlord's complaint must be served on the tenant at least six days before the hearing date (Ala. Code 1975, §6-6-332). If the district judge rules in favour of the landlord, the court files a writ of execution which requires the sheriff to restore the premises to the landlord (Ala. Code 1975, §6-6-337). The tenant may file an appeal of the judge's ruling within seven days, and a trial on the appeal is scheduled within 60 days of the date of the appeal (Ala. Code 1975, §6-6-350). The landlord's right to possession will not be delayed by a tenant's appeal, and can only be prevented if the tenant pays all rent payable before the landlord regains possession by a writ of possession (Ala. Code 1975 §6-6-351).

Provided the remedy is included in the commercial lease, in Alabama a landlord is typically allowed to terminate the lease for failure to pay in a timely manner rent or other amounts due under the lease, for default under the lease (sometimes after a required opportunity to cure), for violation of applicable laws, and other terms specified in the lease.

For residential leases in Alabama, by statute, a landlord may terminate a lease by delivering written notice to the tenant specifying the acts or omissions causing the breach in the following cases:

  • material non-compliance with the lease by the tenant;
  • intentional misrepresentation of a material fact by the tenant;
  • material non-compliance with any of its statutory obligations by the tenant; or
  • the tenant does not pay rent when due.

Ala. Code 1975 §35-9A-421(a) and (b). If the breach arises from unpaid rent or other curable breaches, the lease shall terminate within seven days of receiving the notice if not remedied by the tenant, as specified in the statute. Other breaches are not curable, including (i) intentional misrepresentation of a material fact, and (ii) certain acts on the premises (eg, possession of illegal drugs or criminal assault); Ala. Code 1975 §35-9A-421(b) and (d).

For a residential lease, the landlord must give the tenant seven days' notice of default; if the default is not cured, the landlord may file an unlawful detainer action, notice of which must be posted at the leased premises. The tenant then has seven days from the posting of notice to file an answer. Assuming the tenant does not answer, the landlord may file for a writ of execution with the district court for the county where the leased premises are located, which will be issued to the county sheriff, and it may take several weeks to actually serve and evict the tenant. In total, the process can take several months or longer, based on the specific circumstances of the case; see Ala. Code 1975 §35-9A-461. The terms of a specific lease may require the landlord to provide more time or comply with other additional notice requirements beyond those in the code.

For a commercial lease, the landlord must give the tenant ten days' notice of default (or more, if required under the lease); if the default is not cured, the landlord may file an unlawful detainer action, notice of which must be posted at the leased premises. The tenant then has 14 days from the posting of notice to file an answer. Assuming the tenant does not answer, the landlord may file for a writ of execution with the district court for the county where the leased premises are located, which will be issued to the county sheriff, and it may take several weeks to actually serve and evict the tenant. In total, the process can take several months or longer, based on the specific circumstances of the case; see Ala. Code 1975 §§6-6-310 to 6-6-353. The terms of a specific lease may require the landlord to provide more time or comply with other additional notice requirements beyond those in the code.

Pursuant to its terms, a lease may be terminated by a third party in the case of a condemnation, or a foreclosure on the part of a lender that pre-dated the lease. In the event of a condemnation of the leased premises, "the lessee is entitled to share in the total award only in proportion to [its] interest", State Highway Dep't v Lawford, 611 So. 2d 285, 288 (Ala. 1992), and if the fee owner is satisfied with the award for its interest in the property, but the leasehold owner is not, the circuit court can order a separate trial for the leaseholder on appeal – State v SouthTrust Bank of Baldwin Cty., 634 So. 2d 561, 563 (Ala. Civ. App. 1994). Payment is based on the fair market value of the leasehold interest.

The type of pricing structure used for projects depends on several factors, including the current economic climate, owner desires, financing concerns, and public entity status. In commercial construction projects, there are typically more guaranteed maximum or “fixed price” contracts than open-ended "cost plus" contracts, and in the public works sector, "fixed price" contracts are used almost exclusively.

In addition to what the parties would negotiate into written agreements for services, Alabama law requires a licensed architect to sign off on plans for the design and construction of a project (Ala. Code 1975 §34-2-32). For projects of USD50,000 or greater, a contractor must be licensed by the Alabama Licensing Board for General Contractors (Ala. Code 1975 §34-8-9). If there are engineering requirements, a licensed engineer must be consulted and plans approved by that engineer. In addition, most trades are required to be licensed by their respective governing authority, such as plumbers/gas fitters (Ala. Code 1975 §34-37-1, et seq) and electrical contractors (Ala. Code 1975 §34-36-1, et seq). The owner for each project will typically employ an architect and engineer to work with a general contractor to conceptualise the project, and the general contractor then delegates sub-contracts as necessary, typically without being subject to owner approval, but the owner could contractually retain that right. A poor choice by the general contractor in sub-contracting partners would be addressed by the performance securities addressed below.

Owners and general contractors frequently utilise insurance policies and indemnification agreements in their contracts with each other and in particular with their sub-contractors. Under Alabama law, contribution among joint tortfeasors is unavailable, so the only method to obtain contribution is to contractually oblige the counterparty to indemnification. Waivers are generally acceptable and both interim and final lien waivers are highly recommended. Each payment on a pay application should be accompanied by an interim lien waiver and the final payment (including retainage) should be accompanied by a final, unconditional, lien waiver and hold harmless agreement. Further, limitations or caps on liability can be negotiated into the contract between an owner and the general contractor, in addition to provisions requiring the contractor to post payment and performance bonds from a reasonably acceptable surety.

Delays in construction should always be addressed in the contracting documents. While a “penalty” is not available, the contract can provide for an agreed upon “liquidated damages” provision providing for a certain amount allocated for each day, week, or month that the project is behind schedule, or for each milestone missed. There can be a mechanism for accounting for these delay damages as a “back charge” to the contractor to be deducted from payments due. As additional security for paying material suppliers or remedying defects and delays in construction, an owner and general contractor are entitled to hold back retainage for projects; seeAla. Code 1975 §8-29-3. An owner or general contractor may retain 10% of payments to the general contractor or sub-contractor, respectively; Ala. Code 1975 §8-29-3(i), (j). The retainage may only be taken from the first 50% of the payments for completion, after which “no further retainage shall be withheld”, Ala. Code 1975 §8-29-3(i), (j).

Depending on the size of the project, payment and performance bonds are the most common form of security to guarantee a contractor's performance on a project. As a general rule, the larger the project, the more likely it is for an owner to require more expensive security on a project. Public works are required to be bonded (seeAla. Code 1975 §39-1-1), but there is no requirement for any security or bonding to be posted by a contractor on private work. This is left to the contracting parties, who may employ whatever means they feel are necessary to provide adequate protection. The most common method is for the owner to require both a payment and performance bond from a reputable surety. Other layers of security, such as letters of credit or personal guarantees, may be negotiated into the relevant contract if risk is increased.

Any contractor, labourer, material supplier, or other party who contributes work to the property that improves the property is eligible for a materialman’s lien (seeAla. Code 1975 §35-10-210, et seq). The work provided must be a lasting improvement, not temporary. For example, an architect’s work in providing plans would be lienable, whereas a surveyor’s work would not; Wilkinson v Rowe, 98 So. 2d 435 (Ala. 1957). If the work by the lienor is commenced prior to the “creation” of a mortgage on the property, the lien will take priority over the mortgage – otherwise, the lien will be junior to the mortgage (Ala. Code 1975 §35-11-211). Liens may be removed from the property by transferring the lien to a bond using the statutory framework found in Ala. Code 1975 §35-11-233.

Each governmental jurisdictions will have established a building inspector’s office, which must issue a certificate of occupancy prior to the project being inhabited. Each governmental jurisdiction will establish and adopt the standards for construction in its respective jurisdiction. Inspections are typically required to be conducted, and passed, prior to moving on to each phase of the work.

Alabama imposes a recordation tax upon the filing of a deed or similar instrument conveying an interest in real estate with the county probate court where the real property is located (Ala. Code 1975 §40-22-1, et seq). The tax is USD0.50 per USD500 (rounded up) of value for the property conveyed. The obligation for paying recording tax is upon the buyer because the buyer is the party who tenders the deed for recording. However, the parties do commonly negotiate that economic burden in real estate sales contracts. Under Alabama law, a deed or other instrument conveying such property must include a Real Estate Sales Validation Form (RT-1) to the county probate court at the time the instrument is presented to the probate court for recording. This form must include either proof of the actual purchase price, if the property is being sold, or the actual value of the property (which may be evidenced by a licensed appraisal or the assessor’s current value for the property).

Alabama imposes an income tax that is similar to the federal income tax system (Ala. Code 1975 §40-18-1, et seq). The maximum Alabama marginal income tax rate on taxpayers other than C corporations is 5%. The maximum Alabama marginal income tax rate on C corporations is 6.5%. The seller must report the gain on the sale of the real property on its annual income tax return. Unlike the federal income tax law, Alabama’s income tax law does not contain a preferential rate for long-term capital gains.

In addition, Alabama imposes a withholding of income tax in connection with the sale by non-Alabama resident taxpayers (Ala. Code 1975 §40-18-86). If the seller is an Alabama resident or a “deemed” Alabama resident, no withholding is required provided the seller provides a duly completed affidavit confirming such residency (AL Form NR-AF1). Certain limited types of transactions are exempt from non-resident withholding under §40-18-86 (AL Form NR-AF3). If the seller is not an Alabama resident and if the transaction is not an exempt transaction, then the buyer is generally required to withhold either 3% (where the buyer is an individual) or 4% (where the buyer is an entity) of the purchase price be withheld. However, if the gain recognised on the sale is less than the purchase price, and the seller provides the buyer with an Affidavit of Seller’s Gain (see Form NR-AF2), then the buyer may withhold 3% or 4% of the amount of the gain. If the amount to be withheld, as based on the purchase price or the gain, is greater than the net proceeds of the transfer, then only the net proceeds need be withheld and remitted by the purchaser. Generally, the net proceeds of the sale are the net payments to the transferor as shown on the closing statement, but “net proceeds” may be calculated as the amount of money and other consideration received by the seller after deducting mortgage or other secured debt, ad valorem taxes, sales commissions, title premiums, survey expense, costs for environmental and other reports, and all other closing costs and expenses.

If property being conveyed is located in more than one county in Alabama, there is a procedure to obtain an order from the Alabama Department of Revenue to allocate the value of the property being conveyed among the relevant counties so that the proper recording tax in each county can be determined.

Each municipality is permitted to impose an annual business license tax on business conducted within its taxing jurisdiction, including from the business of leasing of real estate. The business license ordinances imposed by municipalities in Alabama vary based on jurisdiction.

Alabama has two withholding regimes related to Alabama income taxes attributable to non-Alabama resident taxpayers, including non-US taxpayers. The Alabama income tax withholding regime related to sales of Alabama real estate is addressed in §40-18-86 of the Alabama Code which is summarised above. In addition, non-Alabama resident owners of pass-through entities such as partnerships or S corporations are subject to a composite payment regime under §40-18-24.2 (relating to partnerships and other “Subchapter K entities”) and §40-18-176 (relating to S corporations). Under the composite payment regime, the pass-through entity files and directly remits taxes to the Alabama Department of Revenue with respect to the allocable pass-through income of the non-Alabama resident taxpayer, including the share of gain from the sale of real estate by the pass-through entity.

Alabama provides income tax benefits (such as depreciation deductions) under Alabama’s income tax law which are generally consistent with the federal income tax system. 

In certain circumstances, Alabama law provides for certain tax incentives with respect to certain qualifying investments in the state, such as the creation or expansion of industrial or research facilities, data processing centres, relocation of corporate headquarters, investments to rehabilitate certain historic structures, and other qualifying projects. The potential incentives may include abatements related to income tax, state and local sales and use tax, state and local ad valorem tax, and state recording taxes. However, in order to qualify for such incentives, the taxpayer must file required applications and reports and be approved by the proper governmental authorities and agencies in Alabama, and the approved investment must comply with additional compliance requirements. See, for example, Ala. Code 1975 §40-9B-1, et seq; Ala. Code 1975 §40-9F-1, et seq; Ala. Code 1975 §40-9G-1, et seq. Additionally, a summary of Alabama's taxes and tax incentives can be found on the website of the Alabama Department of Revenue.

In general, Alabama’s income tax law incorporates the recent federal income tax law changes. For example, C corporations conducting business in Alabama use the federal taxable income as the base for computing Alabama income taxes; see Ala. Code 1975 §40-18-33. For taxpayers other than C corporations, most (but not all) of the federal tax provisions affected by the recent federal tax reform legislation are also incorporated by reference into Alabama’s income tax system.

For example, Alabama’s income tax law incorporates the changes under the federal tax reform legislation related to the increased expensing rules under §168(k) and §179 of the Internal Revenue Code. Alabama’s income tax law also incorporates the recent changes related to like-kind exchanges under §1031 of the Internal Revenue Code.

Alabama’s income tax law does not include the recently enacted provisions related to qualified opportunity zones contained in §1400Z-2.

Alabama’s income tax law related to net operating losses and capital losses is not coupled to the federal income tax rules related to those items.

Sirote & Permutt PC

2311 Highland Avenue South
Birmingham
AL 35205

205 930 5755

205 212 2870

asigman@sirote.com www.sirote.com
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Sirote & Permutt PC 's attorneys in our Real Estate Practice Area are adept at handling the myriad needs of real estate developers and investors, including assisting our clients in procuring capital and credit, often combining construction, permanent, mezzanine, and tax credit facilities with equity participations. We also handle zoning and other land-use matters, as well as litigation and controversies, including eminent domain, design and construction, environmental regulatory enforcement, ejectments and dealing with insolvent counterparties. Additional contributors: Donald Johnson, Peter Hardin, Samuel Friedman and R Ryan Daugherty.

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