As California residents recover from another devastating wildfire season, property owners are facing tough decisions regarding their insurance payouts and rebuilding options. Many may not realize that failing to properly reinvest their insurance proceeds could lead to substantial tax consequences. For older property owners, exploring a 1033 exchange and transitioning into Delaware Statutory Trusts (DSTs) could be a sensible path to protect their wealth and simplify their investments.

Insurance Proceeds and Tax Implications

When property is involuntarily converted due to destruction from wildfires, insurance proceeds, FEMA assistance, and land value compensation are all treated as taxable unless properly reinvested under Internal Revenue Code Section 1033. This lesser-known provision allows property owners to defer capital gains taxes by reinvesting proceeds into replacement property.

In 2025, the IRS continues to treat compensation as follows:

• Insurance Payouts (Building & Improvements): Subject to capital gains tax if the structure's value exceeds the adjusted tax basis.
• Insurance Proceeds for Land Value: Treated as taxable gain if the proceeds exceed the original land purchase cost.
• FEMA Assistance: Although disaster relief funds for temporary needs may not be taxable, amounts reimbursing property loss can be subject to tax if not reinvested.

If a property owner does not complete a 1033 exchange, proceeds from insurance settlements can trigger significant capital gains taxes, particularly for long-held properties with a low tax basis. In high-tax states like California, this can mean combined state and federal rates exceeding 30%.

1033 Exchange — A Timely Solution

Section 1033 provides wildfire victims the ability to defer these taxes by reinvesting insurance proceeds into a replacement property. Importantly, 1033 exchanges offer more flexibility compared to traditional 1031 exchanges:

• Extended Timeline: Property owners have up to two years from the end of the tax year in which the proceeds were received to reinvest.
• No Need to Identify Properties within 45 Days: Unlike 1031 exchanges, there is no strict identification requirement.
• Flexibility in Debt Replacement: Destroyed properties often carried recourse debt. DSTs can serve as suitable replacements, offering non-recourse debt to satisfy financing requirements.

DSTs: A Passive, Diversified Alternative for Older Property Owners

Many older investors are hesitant to rebuild or acquire another actively managed property. This is where Delaware Statutory Trusts (DSTs) offer a compelling solution:

• Hands-Off Management: DSTs allow investors to own fractional interests in large institutional-grade properties without management responsibilities.
• Diversification: Access to a diversified portfolio of properties across various sectors such as multifamily, medical, industrial, and net-leased retail.
• Debt Replacement: DSTs can incorporate non-recourse financing, allowing investors to replace the debt associated with the destroyed property, meeting exchange requirements.
• Estate Planning Benefits: DSTs offer a seamless transition for heirs, avoiding the complications of managing active properties.

Learn More: Expert Guidance Available

Navigating the complexities of a 1033 exchange can be daunting, especially during the emotional aftermath of losing a property. Our team specializes in helping California property owners maximize tax deferral opportunities while transitioning to stress-free, passive real estate investments. Download our 1033 Exchange ebook to learn more: