Natural disasters and weather hazards continue to impact the United States. Violent tornadoes and hurricanes, unexpected ice storms and heavy snows, and destructive wildfires take their toll on humans and their properties.

Investors involved with 1031 exchanges in an attempt to defer capital gains taxes and depreciation recapture on the sale of investment or business real estate should pay attention to natural disasters. Such occurrences could impact relinquished and replacement properties while hindering the ability to meet the IRS’ in-stone deadlines for a successful exchange.

Interestingly, “disasters don’t yet seem to be substantively impacting exchange volume in high-volume markets where natural disasters have occurred recently,” First American Exchange Company President Julie Baird told Connect CRE. “However, it is a potential long-term risk that investors need to consider.”

Natural Disasters are Growing

According to NOAA’s National Centers for Environmental Information, 27 confirmed weather/climate disasters occurred in 2024, with losses exceeding $1 billion each. This means collective losses topped $182.7 billion.

Baird explained that real estate investors could encounter many challenges following a natural disaster, including increasing property insurance costs and strategy shifts for how and where they might consider 1031 exchanges.

Furthermore, she added that weather-related issues mean that investors should continue to evaluate and re-evaluate their risk management strategies, especially in the area of like-kind exchanges.

The IRS Lends a Helping Hand

“Natural disasters can trigger certain IRS tax relief, as well as 1031 and 1033 exchange benefits for some impacted taxpayers,” Baird said. “This can encourage reinvestment in disaster areas.”

Specifically:

• Revenue Procedure 2018-58 could extend the 1031 exchange deadlines in federally declared disaster areas. The deadlines include a 45-day period for replacement property identification and the 180-day acquisition deadline.

• Depending on the circumstances, an additional 120-day extension or an IRS-designated deadline could be in place.

Baird explained that taxpayers and investors who live or conduct business in federally declared disaster zones could often automatically qualify for the extensions. “In some cases, even those indirectly affected, such as investors whose identified replacement properties were destroyed, may be eligible,” she added.

Damages and Section 1033

A Section 1033 exchange could be helpful if a property is destroyed and the owner obtains insurance or condemnation proceeds. Even if the owner didn’t want to sell the property, receipt of those funds is considered a tax liability. However, the owner could defer capital gains on those payouts if the funds are reinvested in a like-kind replacement property.

“The 1033 exchange allows more time to reinvest the proceeds than a 1031 exchange, and on a schedule that varies, based on the type of property,” Baird explained.

However, the replacement property needs to match what was destroyed. A 1031 exchange allows an investor to exchange investment real estate for other investment real estate. However, with a 1033 exchange, a duplex must be exchanged for other residential property, while a storefront shop must be exchanged for similar retail real estate.

Preparation is Everything

Baird noted that 1031 and 1033 exchanges can be effective tax relief tools for investors dealing with natural hazards and property destruction. However, “taxpayers can consider further mitigating risk by identifying multiple replacement properties in different geographic locations during the identification period,” Baird said. “Diversifying property choices reduces the likelihood of exchange failure due to unforeseen disasters.”

Furthermore, due to the complexity of exchanges, Baird suggested that investors collaborate early and often with Qualified Intermediaries (QIs), tax and legal professionals and insurance experts. Doing so can “help create an investment strategy more adaptive to disaster risk,” Baird said.