The year 2017 has topped all prior years as the costliest on record for natural disasters in the United States. Some estimates put the loss at over $300 billion.
Consider some of the following:
- California: Massive wildfires followed by a drenching rain leading to mudslides
- Houston: Hurricane Harvey
- Florida: Hurricane Irma
- Multibillion-dollar severe weather losses in Idaho (wildfires) and in the Midwest (tornadoes, flooding)
Much of these losses were levied on real estate holdings, whether residential or held for investment.
From just $107.88 $24.99 for Kiplinger Personal Finance
Be a smarter, better informed investor.
Sign up for Kiplinger’s Free Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
If you were unfortunate enough to have lost investment real estate to a disaster, eminent domain or condemnation, you may be faced with yet another loss: income taxes from your settlement proceeds. If you have investment real estate proceeds from insurance or from a forced sale, gain must be calculated based on your depreciated cost basis in the investment.
A Way Out of a Tax Bind: Section 1033
There is a way to defer this taxable event. Section 1033 of the Internal Revenue Code allows for the opportunity to use the proceeds and reinvest them into other investment real estate or reinvest into the rebuilding of the real estate. This rule has similarities to Section 1031 exchanges, but also is much more relaxed in its rules. Section 1031 is a popular option when deciding to sell investment real estate and reinvest the proceeds to defer the income tax. However, the 1033 exchange comes with a couple of distinct advantages:
- With the 1033 exchange, you can receive the proceeds without using a Qualified Intermediary, vs. a 1031 exchange, which requires you to use a Qualified Intermediary.
- With the 1033 exchange, you generally have two or even three years, in some cases, to make the reinvestment. With a 1031 exchange, you only have 45 days to identify replacement property.
Section 1033 is not just for property destroyed from fire, earthquake, hurricane or other disaster. It also applies to property condemned by a governmental exercise of its power of eminent domain. For instance, in the Seattle area Sound Transit is building a rail system costing in the tens of billions, much of this will go to owners of investment property being forced to sell.
But what if you do NOT want to rebuild in the same spot, and you do NOT want to invest all your proceeds into another piece of investment real estate? There is a solution. In a previous article in Kiplinger, I discussed how the Delaware Statutory Trust (DST) could be used to satisfy the requirements of Section 1031 exchanges. The DST also is available for proceeds from condemnation and involuntary conversions.
Avoiding Taxes on a $900,000 Gain
For example, Ben, age 72, owned a small warehouse purchased years ago, with a cost basis of $100,000. The flooding from Hurricane Irma ruined the structure and his customers needed to find other buildings in which to store their goods. Ben is not interested in rebuilding, and even if he did, he isn’t sure he could get his customer base back. If he accepts the $1 million insurance proceeds, he will owe capital gains taxes on the $900,000 gain, and lose all possibility of a future step-up in basis. The step-up on basis potentially allows heirs to permanently eliminate the tax on this $900,000 gain.
Instead, he finds an investment adviser experienced with DSTs. Upon receipt of the insurance proceeds, he spreads the money across various Class A multi-family apartment buildings, and some medical office buildings. Within a month of this reinvestment, he is already receiving his share of the rental income from the DST investments. No more being a landlord, he is receiving monthly cash flow, the opportunity for future appreciation, potential for a future step-up in basis, and best of all, Ben pays no current income tax on the $900,000 gain.
If you were unfortunate enough to have lost investment real estate to natural disaster or governmental condemnation, know that you can at least keep the tax collector at bay with proper planning and execution of a Section 1033 exchange.
-
Investors Buy the Nasdaq's Big Dip: Stock Market TodayStocks are up and down again to end an up-and-down week ahead of big earnings announcements and the eventual return of regular economic data flow.
-
What to Know About Portable MortgagesA closer look at how portable mortgages would work, who might benefit and why the concept is gaining attention amid high rates and limited supply.
-
Here's How to Plan This Year's Roth Conversion, From a Wealth ManagerWhile time is running out to make Roth conversions before the end of the taxable year, consider taking your time and developing a long-term strategy.
-
Four Times You Need a Second Opinion on Your Financial PlanIs your financial plan fit for purpose — or is your adviser peddling an outdated strategy? When you see these red flags, it's time for a second opinion.Evan
-
'But It's Not My Fault!': Your Insurance Company Absolutely Will Blame You in These Five ScenariosInsurance companies care about 'fault' in more ways than you think — from payment mishaps to your neighbor's landscaping — so it's on you to manage the risks.
-
3 Ways High-Income Earners Can Maximize Their Charitable Donations in 2025Tax Deductions New charitable giving tax rules will soon lower your deduction for donations to charity — here’s what you should do now.
-
How to Calm Your Retirement Nerves When It's Time to Shift from Savings Mode to Spending ModeTransitioning from saving to spending in retirement can be tricky, but devising a strategic plan can help ensure a smooth and worry-free retirement.
-
Why Wills and Trusts Aren't Enough in the Great Wealth Transfer, From an Attorney Who KnowsFamilies need to prepare heirs through communication and financial know-how, or all that money could end up causing confusion, conflict and costly mistakes.
-
Private Markets for Main Street: What Financial Advisers' Clients Need to KnowWith product innovation 'democratizing' private market access for everyday investors, advisers must step up their game to educate clients on the pros and cons.
-
Seven Practical Steps to Kick Off Your 2026 Financial PlanningIt's time to stop chasing net worth and start chasing real worth. Here's how to craft a plan that supports your well-being today and in the future.
