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.
Sign up for Kiplinger’s Free E-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.
-
ESPN to Acquire NFL Network and RedZone in Exchange for 10% Equity StakeESPN will take control of NFL Network and RedZone, while the NFL secures a 10% stake in ESPN — a move that could change how fans watch football.
-
Stocks Rally on Apple Strength: Stock Market TodayThe iPhone maker will boost its U.S. investment by $100 billion, which sent the Dow Jones stock soaring.
-
I'm an Estate Planning Attorney: These Are the Two Legal Documents Everyone Should HaveEvery adult should have a health care proxy and power of attorney — they save loved ones time, money and stress if a sudden illness or injury leaves you incapacitated.
-
I'm a Financial Professional: Here's My Investing Playbook for Political UncertaintyFor successful long-term investing in a politically charged environment, investors should focus on economic data, have a diversified portfolio and resist reacting to daily headlines.
-
The Truth About the Dark Side of Rooftop Solar PanelsRampant bankruptcies in the solar panel industry have left many consumers with systems that don't work and no way to get them fixed. Worse, they're being hounded to keep paying despite not receiving what they were promised. What can they do?
-
Six Big Beautiful Opportunities: Advisers' Guide to Tax and Client StrategiesHere are several ways financial professionals can help their clients maximize opportunities in the One Big Beautiful Bill Act, which extends key TCJA provisions, introduces increased deductions for people 65 and older and more.
-
Five Ways to Maintain Charitable Giving During Volatile Times: A Giver's GuideWhen the economic outlook is uncertain, charitable giving is even more important — and impactful. You can be strategic by using donor-advised funds, diversifying assets and prioritizing unrestricted gifts.
-
Avoid Medicare's 'Shadow Tax' With This Financial Expert's IRMAA-Busting TipsYou're cruising along in retirement, and then bam: Your Medicare premiums soar because your income crossed the limit. Take a breath. There could be a solution.
-
Grilling Season and ETFs: There's More Than One Way to Cook Up a PortfolioExchange-traded funds come in a multitude of 'flavors' these days, from passive to active to factor-based. Their flexibility is what makes them so delicious.
-
You Don't Want It, But You Should Plan for It Anyway: An Expert Guide to Long-Term CarePlanning for long-term care is crucial to protect your independence, family and financial stability against unexpected health events and rising care costs not covered by standard insurance.
