Estate Planning Newsletter
Estate and Income Tax Treatment of Contaminated Property
The Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA) imposes liability for the investigation and cleanup of contaminated real property without regard to whether the landowner created or allowed the original contamination of the site.
In the 1990’s EPA officials began to refer to sites suspected of being only slightly contaminated, such as those used for light industrial purposes, including gas stations, dry cleaners and similar businesses, as “Brownfields.” In 2002, President Bush signed into law the Small Business Liability Relief and Brownfields Revitalization Act (the “Brownfields Act”), providing some protection from CERCLA liability for landowners seeking to redevelop Brownfields property.
Tax Court Allows Valuation Discount for Environmental Liability
The Tax Court has allowed a lack-of-marketability discount when valuing a contaminated property for estate tax purposes. In Estate of Pillsbury (1992), the court reasoned that contaminated real property may be discounted in value for estate tax purposes if a reasonable buyer would have taken such contamination into consideration in purchasing the property on the date of the landowner’s death.
The Tax Court has also provided a measure for determining the amount of valuation discount; in Estate of Necastro (1994) the court decreased the value of the property by the reasonable cost of cleaning up the contamination known to exist at the landowner’s date of death. The Necastro court stopped short of allowing a further discount for the potential of “contamination stigma”- the decrease in value due to fear of potential contamination. Later cases have rejected contamination stigma as the basis for a valuation discount where the facts of the case fail to establish that a potential buyer would discount the purchase price of the property due to the existence of potential contamination.
Income Tax Treatment of Environmental Expenses
Internal Revenue Code Section 198 was enacted as part of the Taxpayer Relief Act of 1997. Section 198 allows a taxpayer to elect the deduction of all or a portion of “qualified environmental remediation expenditures” as defined in the Code, as an ordinary business expense in the year incurred. “Remediation” is defined as expenses “paid or incurred in connection with the abatement or control of hazardous substances at a qualified contaminated site.” The provisions of Section 198 were extended through December 31, 2009.
Amendments in December of 2006 expanded the types of properties eligible for the incentives to include properties contaminated by petroleum products. Oil would be included in the definition of a “hazardous substance”, allowing taxpayers to deduct the cost of remediating property contaminated by oil spills.
Upon the sale of the property, the deductions claims by taxpayers for remediation costs would not be recaptured as ordinary income. Under Section 198, the deduction may have to be recaptured under I.R.C. Section 1245 when the taxpayer sells or otherwise disposes of property that would have received an addition to basis if the taxpayer did not elect the Section 198 deduction.
Amended tax returns may be filed to deduct expenditures from previous years. IRS guidelines state that such returns must be filed within three years after the date a corporation filed its original return, or within two years after the date a corporation paid the tax (if filing for a refund), whichever is later.
Environmental expenses not covered under Section 198 are subject to Internal Revenue Code Section 162, Revenue Rulings and Private Letter Rulings issued by the Internal Revenue Service. Section 162, related rulings and case law have determined that environmental expenditures are currently deductible business expenses if they meet all of the following requirements:
- The property was acquired in a clean state and polluted during the course of ordinary business operations;
- The site was restored to its original clean condition; and
- The cleanup did not allow for the property to be put to a new use.
- Environmental expenditures not meeting the above requirements must be capitalized. Expenses related to the remediation of asbestos contamination do not fall within the definition of a “hazardous substance” under Section 198 and will continue to be treated as capital expenditures.