Lost Your Investment Real Estate to a Natural Disaster? Don't Get Caught in a Tax Trap
If your property was flattened by hurricane, fire or even by an eminent domain project, you might have gotten a big settlement check. But that could also mean a hefty tax bill. To avoid that, consider this maneuver.


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.
Profit and prosper with the best of Kiplinger's advice on investing, taxes, retirement, personal finance and much more. Delivered daily. Enter your email in the box and click Sign Me Up.

Brian Evans, CPA/PFS is the owner of Madrona Financial Services and Bauer Evans CPAs, a well-known registered investment advisory practice and an accounting firm based out of Seattle, Washington. He serves as their Chief Executive Officer, lead Wealth Planner and Senior Portfolio Manager. Evans also hosts a weekly radio show and podcast, Growing Your Wealth, in Washington on KTTH, KIRO, KNWN and KVI, and on KNRS in Utah.
-
The Upscale Upgrades Coming to a Country Club Near You
Young country club members expect more from their fees than access to a golf course. From teen rec rooms to red-light therapy, this is how clubs are upgrading.
-
I claimed Social Security six months ago at 62, but my checks are too small. What are my options?
We asked financial experts for advice.
-
Five Retirement Planning Traps You Can't Afford to Fall Into, From a Wealth Adviser
To help ensure you reach your savings goals and enjoy financial security in your golden years, be aware of these common pitfalls. The key is to be proactive, informed and flexible.
-
Your 401(k) Can Now Include Alternative Assets, But Should It? A Financial Adviser Weighs In
Many employer-sponsored plans offer limited investment options, which can stunt growth. But participants considering alternatives might need some sound advice to get the most from their accounts.
-
Will Taxes Shred Your 401(k) or IRA During Your Retirement? It's Very Likely
Conventional wisdom dictates that you save in a 401(k) now and pay taxes later, but turning that rule on its head could leave you far better off. A financial planner explains why.
-
More Retirees Are Renting: Should You? A Financial Adviser Weighs In
In some ways, renting is cheaper, more flexible and easier, but unless you understand the implications for your taxes and health costs, it might not be for you.
-
I'm a Real Estate Investing Pro: This 1031 Exchange Strategy Can Triple Your Cash Flow
Savvy investors can use 1031 exchanges to unlock value by moving capital across markets in a play called geographic arbitrage. These tax implications can make or break the strategy.
-
I'm an Insurance Pro: Everyone Needs to Prepare for Earthquakes, Even if You Don't Live Near a Fault Line
Here are my tips for what to do before, during and after an earthquake. The more prepared you are, the more you'll be able to keep your wits about you if it happens.
-
Claiming the Standard Deduction? Here Are Five Tax Breaks for Retirement in 2025
Tax Tips If you’re retired and filing taxes, these five tax credits and deductions could provide thousands in relief (if you qualify).
-
Where There's a Will, There's a Way Your Assets Will Be Distributed as You Wish
Your will is the backbone of a strong, adaptable estate plan that ensures what you leave behind goes to your selected beneficiaries. Without a will, state laws determine who gets your assets.