Deductibility of environmental remediation costs.

• Author: Gibbs, Paul K.

In Letter Ruling(TAM) 9952075, the IRS held that the costs of remediating post-acquisition contamination are currently deductible under Rev. Rul. 94-38. However, environmental remediation costs are capitalizable under Secs. 263 and 263A to the extent they are for pre-acquisition contamination. At issue was the treatment of the costs to remediate land containing both pre- and post-acquisition contamination in preparing for new construction, which led the examining agent to conclude the costs were capital and, therefore, distinguishable from Rev. Rul. 94-38.

Background

Rev. Rul. 94-38 involved a manufacturer that owned and operated a manufacturing plant built on land on which the taxpayer buried hazardous waste discharged from its manufacturing operations. The land was not contaminated by hazardous waste when the taxpayer purchased it. To comply with Federal, state and local environmental requirements, the taxpayer decided to remediate the contaminated soil and groundwater, and establish a continuous monitoring system. The taxpayer also constructed groundwater treatment facilities that would remain in operation for approximately 10 years. During this time, the taxpayer would continue to monitor the groundwater to ensure compliance with applicable environmental laws. During and after the remediation and treatment, the taxpayer continued to use the land and operate the plant in the same manner as it did prior to remediation, except that new hazardous waste discharges were disposed of in accordance with applicable environmental laws.

Rev. Rul. 94-38 held that the soil remediation and groundwater treatment costs could be deducted currently; however, the costs of constructing the groundwater treatment facilities had to be capitalized and depreciated. The Service concluded that neither the soil remediation nor the ongoing groundwater treatment costs (other than those to construct the facility) produced a permanent improvement to the taxpayer's land or otherwise provided a significant future benefit. The IRS further concluded that the appropriate test for determining whether expenditures increase the value of property was to compare the status of the asset after the expenditures with the status before the condition arose that necessitated the expenditures (i.e., before the land was contaminated), citing Plainfield-Union Water Co., 39 TC 333 (1962), nonacq. on other grounds, 1964-2 CB 8. Under the facts in Rev. Rul. 94-38, the soil remediation and...