Environmental issues: an overview of tax policy.

• Author: Barker, Thomas G., Jr.

While U.S. environmental policy encourages cleanup and development, the overall tax policy does not provide incentives for cleaning costs. It is unlikely that the IRS will reconsider its current position or that Congress will subsidize cleanup costs through changes to the tax law. Therefore, any taxpayers facing significant environmental costs, such as the development of wetlands, the costs of soil conservation or the removal of hazardous substances, should consider the important tax issues related to the capitalization of cleanup costs.

Wetlands

For many years, the Internal Revenue Code indirectly supported the development of wetland resources. For example, provisions that encouraged the destruction of wetland areas for agriculture or investment purposes allowed any profits realized on land converted from wetlands for irrigation purposes to be deducted as conservation expenses. Also, a deduction was allowed for expenses incurred in land clearing activities. All of these provisions have been amended to remove the tax incentives for the destruction of wetland areas.

Sec. 1257 creates ordinary income on the disposition of converted wetlands and eliminates the prior incentive of treating profits from the sales as capital gains. This section specifically pertains to the sale of converted wetlands or highly erodible cropland. Profits from the sale of land previously converted from wetland must be treated as ordinary income. The wetland provisions of this section apply both to any person who has caused the conversion of wetland to farmland and to any person who has farmed the converted land area at any time. In addition to the elimination of the capital gain incentive in Sec. 1257, Sec. 182 has been repealed, eliminating deductions for expenses incurred in land clearing activities.

Other provisions that allow deductions for soil and water conservation expenditures no longer apply to expenditures related to wetlands destruction. Sec. 175, which provides a deduction for soil and water conservation expenses, specifically excludes expenditures in connection with the draining or filling of wetland areas.

Soil Conservation

Farmers who implement soil conservation activities, even if they are capital in nature, may deduct their expenses. Expenditures incurred for soil and water conservation related to land used in farming, or for prevention of erosion on land used for farming, are deductible costs. To qualify for the deduction, the farmer must meet...