Has a tropical storm or some other disaster damaged your investment property? To add insult to injury, you may be liable for tax to the extent that insurance reimbursements or condemnation awards exceed your adjusted tax basis in the property. This is known in tax lingo as an “involuntary conversion” gain.

Strategy: Repair the property or replace it before the tax-law deadline. If you meet the deadline, you can defer the taxable gain by making a special tax return election. To qualify for the gain deferral privilege, repair and/or replacement expenditures should generally be made within two years of the close of the tax year in which the involuntary conversion event occurred. A three-year window applies if the property is condemned. In either case, you can apply for an extension. Other special rules apply to property owned in an area designated as a federal disaster area. See your tax pro for more details.

Here’s the whole story: If the damaged property is simply replaced by the applicable deadline, any taxable gain is automatically deferred if you elect the gain deferral privilege. Even if you elect gain deferral on the return for the year in which the damage occurred, you still must report a taxable gain to the extent that any replacement property costs less than the amount received as compensation. The tax basis of the new property is reduced by the amount of the deferred gain. If you’ve already reported the taxable gain from an involuntary conversion, make the tax return election and obtain a refund. This can be accomplished by reinvesting the insurance proceeds within the two-year period (or longer if an extension has been granted) and filing an amended return.

Tip: The deferred gain on an involuntary conversion is recognized as a taxable gain when the investment property is sold or exchanged.