constructing groundwater treatment facilities to extract. treat, and monitor contaminated groundwater. An important fact stipulated in the revenue ruling is that "the effect of the soil remediation and groundwater treatment will be to restore [the taxpayer's] land to essentially the same physical condition that existed prior to the contamination:' This was the exact situation outlined in the second TAM where the IRS concluded that the costs should be capitalized. The IRS's holding in the revenue ruling, however, is completely opposite, and appears to remove the economic disincentives of the previous position. Based on the circumstances presented in the revenue ruling, the IRS concluded that the costs incurred to cleanup land and to treat groundwater that a taxpayer contaminated with hazardous waste from its business are deductible by the taxpayer as ordinary and necessary business expenses under IRC Sec. 162. The costs attributable to the construction of groundwater treatment facilities are capital expenditures under IRC Sec. 263A. In the revenue ruling. the IRS first stated that the IRC "generally endeavors to match expenses with the revenues of the taxable period to which the expenses are properly attributable, thereby resulting in a more accurate calculation of net income for tax purposes." In addition, relying on Indopco. the IRS acknowledged that in determining whether expenditures may be currently deductible or capitalized, it is important to consider the extent to which the expenditure will produce significant future benefits. Applying the above points to the taxpayer's situation, the IRS held that the soil remediation expenditures and ongoing groundwater treatment expenditures "do not produce permanent improvements to Ithe taxpayer's] land within the scope of IRC Sec. 263(a)( I) or otherwise provide significant future benefits." Furthermore. the ruling concluded that the appropriate test for determining whether the expenditures increase the value of property is the test outlined in Plainfield-Union. In evaluating the potential increase in value to the taxpayer's land due to the soil remediation costs, the IRS concluded that the taxpayer "merely restored its soil and groundwater to their approximate condition before they were contaminated by fits] manufac-
turing operations:' In the ruling, the IRS also supports the current deduction for the soil remediation expenditures and ongoing groundwater treallnent expenditures by indicating the costs are not subject to capitalization under IRC Sec. 263(a)(2)because the contamination was not present when the property was acquired. Deductions were also justified because the land was not subject to an allowance for depreciation. amortization. or depletion. Finally, the IRS concluded that the expendilUres (other than the costs attributable to the construction of facilities) are "appropriate and helpful in carrying on [the taxpayer's] business and are commonly and frequently required in [the taxpayer'sl type of business." As expected. the IRS concluded that the groundwater treatment facilities constructed by the taxpayer have a useful life beyond the taxable year in which they are constructed. Consequently, these costs are capital expenditures under IRe Sec. 263(a). In addition, the taxpayer is required to capitalize the direct costs and a proper share of allocable indirect costs of constructing these facilities under IRe Sec. 263A.
Iy increase in relation to its value when acquired in a contaminated condition. Interestingly, the IRS, in response to a request for reconsideration. has withdrawn the holding but not the philosophy of TAM 9S-41 DOS. The withdrawal letter at the writing of this article has not been officially released. Surprisingly, and of concern 10 taxpayers, the withdrawal was based solely on a reconsideration of the facts of the case. The taxpayer was able to convince the Service that there was not an actual break in the ownership of the property and that the lax payer did own the property when it was contaminated. The taxpayer owned and contaminated the property, sold it to a subsidiary, who donated the property to a county, who discovered the contamination and conveyed it back to the subsidiary. The IRS' reliance on the facts, rather than disavowing the philosophy expressed in the TAM, leads to a strong inference that the nondeductibility philosophy for pre-contaminated property expressed in TAM 9S-41 OOS will be followed in the future. Obviously. individuals involved in the acquisition of property must carefully consider the possible tax treatment of their liability for cleanup costs.
PRE-CONTAMINATED PROPERTY (BUYER BEWARE) The IRS has recently signaled that the rationale of Rev. Rut. 94-38 on the deductibility of cleanup costs will likely be limited to situations where a taxpayer contaminates its own property. So what happens when a taxpayer acquires by purchase or merger pre-contaminated property? In Technical Advice Memorandum 9S-4100S,issued September 27, 1995, the IRS dealt with a situation where the taxpayer was thought to have purchased land in a contaminated condition. The Service carefully distinguished Rev. Rut. 94-38 by contending it only applied to situations where the taxpayer first purchased or owned property in a clean condition and then contaminated the property. The Service contended that the cleanup costs for property acquired in a contaminated condition are not deductible because the cleanup produced a more valuable asset rather than merely restoring or mending the property to its original condition. The cleanup costs, said the Service, failed the Plaillfield Union test because the value of the property, when restored, will material路
CONCLUSION The change in position expressed by the IRS in Rev. Rut. 94-38 on cleanup costs when the taxpayer has contaminated its own property has corrected the economic disincentive present in its former position. Taxpayers (at least taxpayers in similar circumstances discussed in this article) who voluntarily comply with environmental laws may now currently deduct their expenses. The IRS' decision to correct the economic disincentives created by its position in the previous TAM is good public policy for both the taxpayers involved and the general public. The IRS's recent contention, however, that cleanup costs should only be deducted when property is purchased in a uncontaminated condition, then contaminated. and only then cleaned up. is logically inexplicable. If the purpose is to protect the environment, and the public, what difference does it make, when a taxpayer is acting in good faith, whether or not property has been acquired in a contaminated condition. The Service's position can only lead to an increase in purchase costs, a concern about predictability, and Il n~ I,tuml,,"W
Sunr, IIII