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By Roy Whitehead, Jr., JD, LLM, Pam Spikes, PhD, CPA, and Paul Jensen, PhD, CPA, University of Central Arkansas

The IRS seems to have extraordinary difficulty making up its mind about the correct position to adopt in regard to the deductibility of environmental cleanup costs. When the IRS issued Rev. Rul. 94-38, the issue of the deductibility of environmental cleanup costs appeared to be put to bed. In Rev. Rul. 94-38, the service indicated that cleanup costs of property contaminated by the current owner who merely restored the property to its original condition rather than increasing its value or prolonging its useful life, were currently deductible. The ruling left unresolved the issue of the deductibility of cleanup costs for property that was purchased in a contaminated condition. A later TAM (95-41005), since withdrawn, based on factual rather than philosophical reasons, created considerable uncertainty because it signaled that the deductibility holding of Rev. Rul. 94-38 is limited to its facts and does not apply to preacquisition contamination of property. This uncertainty created a troubling economic disincentive for the purchase, cleanup, and restoration of contaminated property, fully discussed in Whitehead, et al, "Will the EPA Call the IRS...Again," The CPA Journal, March, 1997.

For the first time, Congress has expressly stated that environmental cleanup costs should be deductible in some cases. Senators Carol Mosely-Braun, D-IL, and Alfonse M. D'Amato, R-NY, in the Senate, and Representative Charles Rangel, D-NY, in the House, have introduced the Community Empowerment Act of 1997, with Clinton administration and broad bipartisan support, to cure the disincentive problem for certain "qualified" property. The act (S.235) will provide a tax incentive in the form of a current deduction for the cleanup costs of property whether contaminated by a past or current owner. The act provides that cleanup costs are deductible if incurred for a "qualified" site. Qualified sites are limited to certain use and geographical requirements. The use requirement is met if the property is held by the taxpayer for use in a trade or business or for the production of income. The geographical requirement is satisfied if the property is located in--

1) any census tract that has a poverty rate of 20% or more;

2) any other census tract (a) that has a population under 2,000, (b) 75% or more of which is zoned for industrial or commercial use, and c) that is contiguous to one or more census tracts with a poverty rate of 20% or more;

3) an area designated as a Federal empowerment zone or enterprise community; or

4) an area subject to one of the 40 Environmental Protection Agency Brownfield pilots announced prior to February 1996.

To claim the deduction, the taxpayer must obtain a statement that the use and site requirements are satisfied from a state environmental agency designated by the EPA.

The expressed purpose of the act is to remove the economic disincentive created by the IRS's narrow interpretation of Rev. Rul. 94-38 and its prodigy and to encourage investors to purchase, clean up, redevelop, and revitalize contaminated property. While the act only applies to qualified property, its good sense economic and public policy approach should influence the IRS to carefully consider reversing the economic disincentives found in its current restrictive approach to the deductibility of cleanup costs. *

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