Question

You are working for a local accountant during tax season and the accountant has asked you to help with the tax preparation needs of Palo Alto, Inc. Palo Alto is a newly formed hi-tech company that specializes in manufacturing security chips for credit cards. The controller of Palo Alto, Michael Smith, would like your help with the following:

(1) Palo Alto is considering purchasing property in California to build its corporate headquarters. The land had previously been used by a manufacturing company, leaving the soil and groundwater contaminated with hazardous waste. To use the property for its needs, Palo Alto will pay for environmental remediation costs to clean up the land. In addition to the purchase price of $800,000, Palo Alto estimates these environmental cleanup costs will be close to $300,000. Should they purchase the property, Palo Alto wants to deduct the full cost of the environmental remediation on this year’s taxes as a trade or business expense. Prepare a tax research memo for Michael Smith explaining whether Palo Alto can deduct the environmental remediation costs from the taxes due this year, or must these costs be capitalized?

Answer 1

Pal Alto, is a company which specializes in the manufacturing of security chips for credit cards and is considering the purchase of property in California. However, the land had previously been used by a manufacturing company, leaving the soil and groundwater contaminated with hazardous waste. Therefore, as per the environmental laws, the company is required to first conduct an environmental audit on such land before purchasing. Moreover, the cost of environmental clean up amounting to $300,000 cannot be deducted as full cost in one year under trade or business expense. This is because of the fact that the remediation cost on land is not in the nature of repair & maintenance as part of ordinary operation of business. Rather the cost to be incurred require the replacement and removal of substantial amount of land that has been contaminated. Due to this activity the business will receive a benefit that would span a period of years rather than just one year and will add substantial value to the asset.  It should also be noted that the remediation was performed to meet government requirements, to provide a safe working environment for the workers, and resulted in an increased market value for the land.

This decision was taken in the ruling of PCB (TAM 9315004), December 17, 1992 by IRS.