Asbestos Removal Costs Deductible

Businesses may deduct environmental remediation costs currently as repairs if the expenditures keep property in an ordinarily efficient operating condition but don’t materially increase its value or useful life. If the expenditures stop deterioration and appreciably extend the property’s useful life, the costs must be capitalized. Previously, the courts had held asbestos removal costs to be capital expenditures. (See Dominion Resources Inc. v. United States, 2000-2 USTC 50,633; Norwest Corp. and Subsidiaries v. Commissioner, 108 TC 265.) In a more recent case, the court held the cost of cleaning contaminated soil also was a capital expenditure. (See United Dairy Farmers, Inc. v. United States, 2001-2 USTC 50,680.) But sometimes the courts take a different approach.

Cinergy, a public utility, built an addition to its office building in 1972. In doing so it sprayed fireproofing material containing asbestos onto the steel structure. In the late 1980s the material began to flake and crumble if touched or disturbed. In 1990 the company paid a contractor approximately $224,000 to remedy the potential health hazard—even though the amount of asbestos in the air was below the levels set by the Occupational Safety and Health Administration. The contractor removed the asbestos in some parts of the building, while in others it encapsulated the substance. The company deducted the project’s costs as an ordinary repair. The IRS disallowed the deduction claiming it represented a capital expenditure. Cinergy paid the additional tax; however, in 1999 it filed suit for a refund in the Federal Court of Claims.

Result. For the taxpayer. The Court of Claims held the company could deduct the expenditures currently since they (1) had not appreciably increased the value of the building, (2) were only a small percentage of the building’s value, (3) had not substantially increased the building’s useful life and (4) had not allowed the company to use the building in a different way. The court distinguished this case from Dominion Resources, where the asbestos removal permitted the owner to put the building to a different use, thus requiring it to capitalize the expenditures.

The court also contrasted this case with Norwest , where the asbestos removal costs were held to be capital expenditures since the company had incurred them as part of a general plan to rehabilitate and renovate the property. Cinergy incurred removal costs as part of a discrete project whose sole purpose had been to solve the asbestos problem. The remediation only restored value to the property that had existed before the deterioration began.

The court also held that the government’s reliance on United Dairy Farmers was misplaced. In that case a company purchased stores that contained underground gasoline storage tanks. Prior to the purchase, these tanks had leaked and contaminated the soil. United had to capitalize the cost of cleaning the soil since the problem existed at the date of its purchase. In contrast, Cinergy did not have an asbestos problem when it completed the building construction. Instead the company constructed property with the potential to require future remediation as opposed to having constructed property containing a defect. The court further said Cinergy could not have anticipated the asbestos problem when it built the building; therefore it could deduct the costs currently.

The Court of Claims drew an analogy between this case and Chicago, Burlington, & Quincy Railroad v . United States, 7401 USTC 9253, to support its conclusion. In Chicago , the court held the costs of water diversion projects to stop the erosion of rail embankments were deductible expenses since the owner had incurred them to stop a problem which, if allowed to continue, would have shortened the property’s useful life. The deduction was allowed even though the erosion abatement work was relatively permanent, had a life of more than a year, had restored the rail embankments to their original condition and had added value. Likewise, in this case, the court held that Cinergy could deduct its costs since the asbestos removal and encapsulation fixed a problem that could have shortened the building’s useful life. Further, the Court of Claims cited a list of courts that allowed current deductions for fixing an unforeseeable problem assuming that work did not increase the value or useful life of the property compared to what it was before the problem existed.

Note: It is important for CPAs to understand how the court determined whether the useful life or value had increased. It compared the value and useful life of the property before the deterioration and after the remediation as opposed to comparing the property’s value and useful life after the deterioration and remediation.

Cinergy Corp. v. United States, 2003-1 USTC 50,602.

Prepared by Charles J. Reichert, CPA, CIA, professor of accounting at the University of Wisconsin, Superior.