Tax and insurance implications can be hard to navigate after the destruction of a property
In commercial real estate, few things are more devastating than losing a property to a natural disaster or accident. Beyond the emotional toll and operational chaos, there’s another layer that catches many owners off guard — tax and insurance implications.
I recently sat down with George Pino, CEO of Commercial Brokers International (and my business partner), to discuss what really happens when disaster strikes. We took questions from social media and went deep into how the IRS treats losses, how insurance payouts are taxed, and what strategies investors can use to protect themselves.
Q1: What are the primary tax implications if a commercial property is destroyed by a natural disaster or accident?
George: The biggest surprise for many owners is that you might still owe taxes even if you lose the property.
But first, let me say — we’re not tax advisors. Every situation is unique, so always consult a professional CPA or tax attorney before taking action.
That said, when a property is destroyed, the IRS looks at how the event occurred and how you handle the aftermath. Depending on the situation, there may still be taxable events triggered by insurance proceeds or changes to your property’s basis.
Q2: How does the IRS treat property loss? Can it be written off as a casualty loss?
George: Yes — but it depends.
For residential properties, you can only deduct casualty losses if the damage happened during a federally declared disaster (hurricane, fire, earthquake, etc.).
For commercial or income-producing properties, it’s different. These losses can be deductible even if they’re not in a federally declared disaster area, as long as the property was used for business or rental income.
Q3: If insurance pays out after a property is destroyed, how is that payment taxed?
George: This depends on what you do with the money.
If you use 100% of the insurance proceeds to rebuild or replace the property, it’s typically not a taxable event.
But if you pocket the funds or decide not to rebuild, the IRS may treat it as ordinary income — not capital gains — which could mean a much higher tax rate.
Also, if the insurance payout exceeds your property’s tax basis, you could owe capital gains tax on that difference. It’s a tricky area where planning ahead makes a big difference.
Q4: What is Section 1033 (Involuntary Conversion) and how does it help defer taxes?
George: Section 1033 is similar to the more familiar 1031 Exchange, but it applies when property is destroyed or taken involuntarily — for example, through fire, flood, or eminent domain.
The key benefit is tax deferral. You can take the insurance proceeds and replace the property within 2 years for residential or 3 years for business/investment properties — and defer the capital gains tax.
The clock starts at the end of the year in which the loss occurred, not the date of the disaster. So if your property was destroyed in May 2025, your three-year replacement window starts on December 31, 2025, giving you until the end of 2028.
Also, unlike a 1031 exchange, a 1033 does not need an accommodator, and the property owner can receive proceeds from insurance directly without causing a tax event, as long as the timelines are met.
Q5: How does depreciation recapture work if a property is destroyed?
George: Depreciation recapture is one of the most misunderstood parts of real estate taxation.
When you own investment property, you get to depreciate it over time — reducing your taxable income. But when that property is sold or lost, the IRS “recaptures” the depreciation by taxing it, usually at your ordinary income rate (up to 25%).
So if your property was destroyed and you receive insurance proceeds instead of rebuilding, you could face depreciation recapture on top of other taxes.
Q6: What if I decide not to rebuild?
George: If you walk away and don’t replace the property, most of the insurance proceeds will be treated as income. You may be able to deduct the land’s remaining basis, but everything else is taxable.
It’s one of those moments where getting professional tax advice can save you a lot of money and stress.
Q7: Do state tax laws differ from federal tax treatment?
George: For most people — about 80% — the answer is no.
Most states align closely with federal tax laws. But in states like California, unique laws like Proposition 13 can complicate things.
For example, if you’ve owned a property for 20 years and your taxes are still based on a $200,000 assessment, an insurance payout could trigger a property tax reassessment at today’s $3 million market value. That’s a serious hit.
Q8: What can property owners do before a disaster strikes to prepare for the tax impact?
George: The number one rule? Document everything. Keep records of improvements and capital expenditures, property valuations and appraisals, any insurance adjustments or correspondence.
You should also understand how your local regulations — such as Coastal Commission rules or California Fair Plan insurance — could affect rebuilding costs.
And be careful with government assistance. Sometimes, grants or rent relief can actually reduce your deductible losses or even be taxed as income. In short — there’s no such thing as “free money.”
Q9: Are there unique tax treatments for properties held in an LLC, trust, or REIT?
George: Not really. Most of these structures are pass-through entities, so the tax consequences flow through to the individual owners. The same casualty loss, insurance payout, and capital gains rules apply — the only difference is how the income is reported.
Final Thoughts
Losing a property to disaster is painful enough. Getting hit with an unexpected tax bill can make it worse.
The key takeaway from George’s insights: plan ahead and document everything. Understand your tax basis, know your insurance coverage, and talk to a qualified tax professional before a disaster happens — not after.
Preparation doesn’t stop disasters, but it can absolutely protect your bottom line when they strike. If you found this blog helpful, please subscribe to our weekly articles— I share weekly insights on commercial real estate investing and brokerage. And drop a comment below — what’s the best story you have about a client that gave you repeat business? Let’s swap some stories.
