Environmental remediation expenditures are capitalizable to contaminated property.

• Author: Madden, David

In Letter Ruling 200108029, the IRS reiterated its position that environmental remediation expenditures are not deductible if a taxpayer purchases contaminated property, even if he had no knowledge of the contamination at the time of purchase and, as a result, presumably overpaid for such property. Additionally, the Service determined that insurance proceeds received as a reimbursement for the incurrence of environmental remediation expenditures were a nontaxable return of capital in the tax year that the taxpayers received the proceeds, to the extent they do not exceed the basis in the property.

Letter Ruling 200108029

In the letter ruling, the taxpayers had to capitalize costs incurred to remediate land purchased in a contaminated state. The costs included expenses paid for consultants, testing, supplies, equipment, labor and legal fees.

Prior to the taxpayers' purchase, the former owners had used the land for storing equipment, oil and empty perchloroethylene (PCE) tanks. The PCE had contaminated the land, which was unknown to the taxpayers when they purchased it. After learning of the previous owners' contamination and being informed by a regulatory agency that the land was contaminated, the taxpayers engaged various consultants to test the extent of the contamination and to remove the equipment causing the contamination. The taxpayers and the regulatory agency eventually reached an agreement that the agency would control all of the environmental assessment and cleanup work, charging the costs to the taxpayers.

Relying on Rev. Rul. 94-38, the IRS determined that the taxpayers had to capitalize the costs incurred to remediate the land. In Rev. Rul. 94-38, the taxpayer had purchased uncontaminated property, but subsequently contaminated it. The taxpayer then incurred costs to clean up the soil and to construct groundwater treatment facilities to remediate the contaminated land. The expenditures for remediating the soil were currently deductible, because the effect of the cleanup was simply to restore the property to its condition prior to the contamination. However, the Service did require the taxpayer to capitalize the costs for the groundwater treatment facilities, because the facilities' value extended substantially beyond the tax year.

In the letter ruling, the IRS determined that, because the land was already contaminated when the taxpayers purchased it, the taxpayers' remediation of the property not only restored the property to its...