Deducting environmental cleanup costs.

• Author: Bliha, Richard

Since the Environmental Protection agency (EPA) was established and the Hazardous Substance Response Trust Fund ("Superfund") legislation was enacted, environmental cleanup activity has increased quite extensively. At the same time, the IRS position on the tax treatment of cleanup costs has also evolved over the past few years. In addition, recent legislation has provided much-needed guidance on the costs associated with environmental cleanup.

Sec. 162 generally allows a deduction for the ordinary and necessary expenses paid or incurred during the tax year in carrying on any trade or business. Sec. 263 generally prohibits deductions for capital expenditures, and Sec. 263(a)(1) provides that no deduction is allowed for any amounts paid out for new buildings or for permanent improvements or betterments made to increase the value of any property. Sec. 263(a)(2) provides that no deduction is allowed for any amount spent to restore property or to make good the exhaustion thereof for which an allowance has been made in the form of a deduction for depreciation, amortization or depletion.

Regs. Sec. 1.263(a)-1(b) provides that capital expenditures include amounts paid or incurred (1) to add to the value or substantially prolong the useful life of property owned by the taxpayer, such as plant or equipment, or (2) to adapt property to a new or different use. Regs. Sec. 1.263(a)-2(a) provides that capital expenditures include the costs to acquire, construct or erect buildings, machinery md equipment, furniture and fixtures, and similar property with a useful life extending substantially beyond the tax year.

In Rev. Rul. 94-38, the Service allowed a deduction for costs incurred to clean up land and to treat groundwater that a taxpayer contaminated with hazardous waste from its business, other than costs attributable to the construction of groundwater treatment facilities determined to be capital expenditures under Sec. 263. In this ruling, the taxpayer acquired the land in a clean state, polluted it with waste from its manufacturing operations, and then stored the waste on its land. The cleanup involved the removal of the contaminated soil, its replacement with clean soil and the installation of pumping and filtration equipment to clean the groundwater contaminated by seepage of the waste. The IRS ruled that the remediation and ongoing groundwater treatment expenditures did not result in improvements that increase the value of the property; the...