I watched a news story tonight that broke my heart. A woman had been living in a FEMA trailer for almost two years while she cleaned out her home after Hurricane Katrina. The house, located somewhere along the Gulf Coast, was ready for occupation when it went up in flames while the woman was at work. Although the house didn't "burn to the ground," it was a total loss.

The rub was that this woman had purchased more flood insurance for her home, but since that insurance cost her so much she didn't - rather, couldn't - purchase homeowner's insurance. Her predicament was so ironic that it became newsworthy.

But her situation posed a few questions. Was she left holding the bag after this loss, or could she expect some tax relief? If she could afford premiums for homeowner's insurance, would those payments be tax deductible? So I searched for answers, and I discovered that if a home or its possessions are damaged, destroyed, or stolen, the homeowner might receive a tax deduction even if the home wasn't insured. But, the loss is easier to take if you do maintain insurance.

Before you suffer a loss, read your policy carefully to determine what is and isn't covered under Section 1 in that policy. That section will explain the types of property coverage, list the specific problems that you're insured against, and describe any exclusion. This section will also detail any conditions you must meet for effective coverage.

As we all learned from news stories after Katrina, homeowner's insurance may or may not reimburse you for your loss. In just as many cases, homeowners may be partially reimbursed or refused compensation when it cannot be determined whether that loss occurred by, say, wind or water. But even if the insurance company refuses payment, the insurance holder may be entitled to some tax relief.

In cases where partial or no reimbursement results, and if your home is damaged or destroyed in an accident or by an act of nature, you may be able to claim a casualty loss deduction on your federal tax form. This income tax deduction may provide relief for individuals who lost a home through an identifiable event that is sudden, unexpected, or unusual (which may or may not include predicted hurricanes), or when personal possessions are stolen, damaged, or destroyed.

To file this loss, you must file federal Form 1040 [PDF] and itemize your deductions on Schedule A [PDF]. For individual taxpayers, the casualty or loss deduction is subject to two limitations:

1. You cannot deduct the first $100 of any loss;
2. If your loss exceeds $100, you can only deduct casualty and theft losses if the total amount lost exceeds ten percent of your adjusted gross income.

If your insurer reimburses you for your losses, you must subtract the reimbursement amount when you calculate your losses for tax purposes. If you don't file your insurance in a timely manner, you won't be able to deduct anything, and you may have to add the reimbursement to your taxes as income.

Say this woman who lost her home to fire purchased her home years ago for $30,000 (she had raised six sons in that home). And, perhaps, the home was worth $75,000 on the local market immediately before the fire. After the fire, the home is basically worth $15,000; but if she had insurance, the insurance company might pay her $45,000 for her loss. This is how she would file that loss on her taxes if she had been reimbursed:

1. She would first note the adjusted basis before loss, which would be $30,000.
2. She would then subtract any reimbursement (none in her case).
3. She would then note the decrease in the property's Fair Market Value ("FMV") ($75,000 minus $15,000 = $60,000).
4. Her loss would be $30,000, because she would have a choice between the smaller of 1 or 2 above.

But this woman still must apply the two deduction limitations ($100 deductible and ten percent of the adjusted gross income) to determine the final amount of the casualty loss deduction on Form 4684 [PDF].

If you take a quick glance at the items listed on Form 4684, you may realize that you need to review more than your homeowner's policy. You might want to talk to a professional insurance and/or real estate adjuster about your adjusted basis cost (which may increase or decrease depending upon various events) and about your home's current FMV. These prices may determine the amount and type of insurance and deductible that you want to maintain on that home.

You usually need to pay a deductible before the insurer will reimburse you for partial or full loss, but you may be able to deduct the deductible on your income tax as a "theft loss" on the return.

Finally, you cannot deduct those premiums if those insurance costs cover personal property. But, if you have a home office and if you qualify to take a home office deduction, you may be able to deduct a portion of your housing expenses, including a percentage of that homeowner's insurance premium. Once again, look long and hard at that policy, as that insurance may not cover business equipment in the home or a client who slips and falls at your home.

Did the Gulf Coast woman suffer a total loss? No, she can still deduct the loss on her taxes after she applies the $100 deductible and ten percent of the adjusted gross income rule. But, unlike an insured homeowner who receives money for a loss, she may not receive a refund from the IRS. Instead, the loss of her home simply may reduce the amount of taxes she might have paid for this year.

Until Next Week,
Linda Goin