Tax treatment of asbestos abatement costs: November 6, 1996.

The Department of the Treasury and the Internal Revenue Service have been reviewing whether asbestos abatement expenditures may be deducted currently or must be capitalized. The current guidance on this important issue is contradictory, with revenue agents aggressively citing the IRS's private ruling position - as reflected in Technical Advice Memorandum 9411002 (Nov. 19, 1993) (hereinafter the TAM) - to require capitalization of such costs, while taxpayers generally deduct such costs, citing section 162 of the Internal Revenue Code on the treatment of ordinary and necessary business expenses. As important, the only published guidance on the treatment of environmental clean-up costs, Rev. Rul. 94-38,(1) permits an ordinary and necessary deduction for the costs of removing environmentally hazardous PCBs in soil and groundwater clean-ups. TEI is pleased to submit these comments in respect of this important issue.

Background

Tax Executives Institute is the principal association of corporate tax executives in North America. Our nearly 5,000 members represent more than 2,700 of the leading corporations in the United States and Canada. TEI represents a cross-section of the business community, and is dedicated to the development and effective implementation of sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and government alike. As a professional association, TEI is firmly committed to maintaining a tax system that works - one that is administrable and with which taxpayers can comply.

Members of TEI are responsible for managing the tax affairs of their companies and must contend daily with the provisions of the tax law relating to the operation of business enterprises. We believe that the diversity and professional training of our members enable us to bring an important, balanced, and practical perspective to the issues raised by the proper treatment of asbestos remediation expenditures.

Treatment of Asbestos

Abatement Costs in TAM

9411002

In Technical Advice Memorandum 9411002, the taxpayer acquired a warehouse and boiler house for use in the taxpayer's business of providing warehouse space and related services. The principal function of the boiler house was to provide heat for the warehouse. Both the warehouse and the boiler house contained asbestos as an insulating material. As a condition to securing a bank loan to expand its facility, the taxpayer in the TAM was required to (i) remove the asbestos from the boiler house and (ii) encapsulate the asbestos contained in pipe insulation in the warehouse. As part of the expansion of the business facility and removal of the asbestos material, the taxpayer converted space in the boiler house to a garage and office. The conversion was funded in part by the bank loan.

The TAM permits the taxpayer to deduct the asbestos encapsulation costs but requires capitalization of the costs incurred in removing asbestos from the boiler house. This latter decision was reached, the TAM provides, because "these expenditure add to the value of the taxpayer's property and adapt such property to a new and different use." In so concluding, the TAM distinguished Plainfield-Union Water Co. v. Commissioner,(2) in which the Tax Court permitted the taxpayer to deduct the cost of removing a tar lining from water pipes in order to install a concrete lining thereby permitting the pipe to continue its principal function of carrying water. Plainfield-Union holds that, for purposes of determining whether an expenditure increases the value of property and therefore must be capitalized, the proper comparison is between the value of the property after the expenditure and the value of that property immediately before the condition requiring the expenditure. Under the facts in Plainfield-Union, the Tax Court concluded that the expenditures did not increase the value of the property.

The TAM concludes that, unlike the costs at issue in Plainfield-Union, the costs incurred by the taxpayer in removing the asbestos "increased the value, use and capacity of the taxpayer's property as compared to the status of its property in its original asbestos-containing condition." In particular, the taxpayer's expenditures (i) permanently eliminated a health risk, resulting in better operating conditions and preventing further contamination, (ii) made the property "significantly more attractive to potential buyers, investors, lenders and customers," and (iii) "enhanced the usefulness and capacity of the taxpayer's property by enabling the taxpayer to provide office space and a garage in the space made available by the elimination of the asbestos hazard." The TAM further observes:

Thus, unlike the costs incurred in Plainfield-Union, the costs incurred to remove asbestos from the taxpayer's boiler house did not return the property to the state that it was in before the condition necessitating the expenditure arose. Under these facts, the condition necessitating the expenditure was the original condition of the property when the taxpayer acquired it. Thus, the asbestos removal costs increased the value, use and capacity of the taxpayer's facility as compared to its original asbestos-containing condition.

By contrast, the TAM concludes that the taxpayer's encapsulation expenses did not appreciably increase the value of the warehouse, did not substantially increase its useful life, and did not adapt the property to a new or different use. The environmental hazard of asbestos was...