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.

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.
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.
-
Is It Time to Cut the Cord on Your Landline?
With rising costs and evolving technology, many are rethinking their home phone service. Here's how to decide if it's time to let go.
-
Parents Prepare: Trump's Megabill Brings Three Crucial Tax Changes
Tax Changes Are you a parent? The so-called ‘One Big Beautiful Bill’ (OBBB) impacts several key tax incentives that can affect your family this year and beyond.
-
I'm a Financial Planner: Here Are Five Smart Moves for DIY Investors
You'll go further as a DIY investor with a solid game plan. Here are five tips to help you put together a strategy you can rely on over the years to come.
-
Neglecting Car Maintenance Could Cost You More Than a Repair, Especially in the Summer
Worn, underinflated tires and other degraded car parts can fail in extreme heat, causing accidents. If your employer is ignoring needed repairs on company cars, there's something employees can do.
-
'Drivers License': A Wealth Strategist Helps Gen Z Hit the Road
From student loan debt to a changing job market, this generation has some potholes to navigate. But with those challenges come opportunities.
-
Financial Pros Provide a Beginner's Guide to Building Wealth in 10 Years
Building wealth over 10 years requires understanding your current financial situation, budgeting effectively, eliminating high-interest debt and increasing both your income and financial literacy.
-
You're Divorced, But the Work Isn't Over: A Guide to Five Financial Tasks to Do ASAP
Once your divorce is settled, don't waste time. You've got to tie up some important loose ends or risk losing money and facing tax consequences.
-
Five Mistakes to Avoid in Your First Year of Retirement
Retirement brings the freedom to choose how to spend your money and time. But choices made in the initial rush of excitement could create problems in future.
-
I'm an Investing Expert: This Is How You Can Invest Like Warren Buffett
Buffett just invested $15 billion in oil and gas, and you can leverage the same strategy in your IRA to potentially generate 8% to 12% quarterly cash flow while taking advantage of tax benefits that are unavailable in any other investment class.
-
Integrity, Generosity and Wealth: A Faith-Based Approach to Business
Entrepreneurs who align their business and financial decisions with the biblical principles of integrity, generosity and helping others can realize impactful and fulfilling success.