The effective utilization of environmentally impaired properties has captured nationwide attention. In addition to state and local efforts, Congress has addressed the problem with a number of separate but coordinate incentives for development. Among them are inducements contained in the Internal Revenue Code ("IRC"). While a provision in the IRC gives developers some incentives to invest in the redevelopment of brownfields, it is not an entirely unmixed blessing.
One significant inducement is the tax incentive available to brownfield investors. While tax implications are taken into account in all transactions, in the brownfield context, the income tax treatment of environmental cleanup cost is a key factor in determining the actual cost of a brownfield project. While tax incentives exist on the federal, state, and local levels, this article will focus on the federal income tax treatment of environmental cleanup costs.
While frequently used, the term "brownfields" is somewhat imprecise. Generally speaking, the term brownfield refers to older abandoned properties that have suffered either some degree of contamination or as to which there is a perceived stigma of environmental contamination. The United States Environmental Protection Agency ("EPA") defines brownfields as "abandoned, idled, or under used industrial commercial sites where expansion or redevelopment is complicated by real or perceived environmental contamination that can add cost, time, or uncertainness to redevelopment projects."
The United States Office of Technology Assessment ("OTA") provides an even broader definition - " a site whose redevelopment may be hindered not only by potential contamination, but also by poor location, either old or obsolete infrastructure, or other less tangible factors linked to neighborhood decline." Brownfield sites are not only those that are seriously contaminated. For example, they are not on the nations Priority List ("NPL"), which is a list of the most contaminated sites that pose a threat to public health and the environment.
Even though most brownfield sites are not on the NPL, developers are hesitant to take part in a brownfield project due to many barriers posed by existing regulation and administrative procedures. Some historical and current obstacles include ambiguous legal liability, lack of concentrated expertise, substantial capital cost, insufficient financing, vague federal, state and local environmental policies, competition from greenfields , absence of consistent redevelopment framework, and public opposition.
Many incentives have been instituted by industry, state, and federal agencies. For example, the EPA announced a Brownfield Action Agenda in 1995, which aimed at encouraging the redevelopment of brownfields. Also, elimination of the current legal obstacles to brownfields redevelopment continues to be one of the major agenda items for Congress and proposed brownfields related legislation. Furthermore, states have taken the lead with voluntary cleanup programs, which offer varying degrees of creative incentives for cleaning up brownfields.
Comprehending the federal income tax treatment of environmental cleanup costs is crucial to brownfields development because of the tremendous amount of money involved in remediating sites. It has been estimated that the cost of remediating known brownfields sites could be in excess of 650 billion dollars.
Cleaning up contaminated property raises a pervasive and to some extent unsettled tax issue: whether the cost can either be currently deducted or must be capitalized. The tax treatment of environmental cleanup costs has significant financial implications. Generally, ordinary business expenses can be deducted against ordinary income in the year incurred. Capital expenditures, on the other hand, are either amortized or depreciated over some fixed period of time. Therefore, to the extent cleanup costs must be capitalized, they cannot be deducted from income in the year incurred.
Section 163 of the IRC generally allows a deduction of the "ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business." However, the rule of deductibility under Section 162 is limited by Section 263. Section 263 generally prohibits deductions for capital expenditures. Section 263(a) provides that "no deduction shall be allowed for any amount paid for new buildings or for permanent improvements or betterments made to increase the value of any property. Capital expenditures can be deducted over a period of time, either through depreciation or amortization.
While easily defined, the distinction between a capital expenditure and a deductible expense is often unclear. The United States Supreme Court has acknowledged that the distinctions "are those of degree and not kind." Since there is no clear dividing line to distinguish between deductible expenses and capital expenditures, courts have adopted a case-by-case approach in determining the treatment of certain items.
One of the most common approaches used to distinguish business expenses from capital expenditures is to determine whether the cost are in the nature of a repair or an improvement. Repairs, which maintain property in normal condition, are deductible expenses. On the other hand, improvements, which increase the value of property, must be capitalized. However, since all repairs in some sense add to the property's value, making the distinction between deductible repairs and non-deductible improvements has produced mixed results.
Further adding to the problem, Sections 162 and 263 do not expressly deal with remediation expenses. However, Section 198 does address the deductibility of environmental remediation expenses, but it only deals with cleanups at certain qualified sites.
Section 198 of the IRC is deigned to encourage environmental cleanup costs by providing a tax incentive in the form of an immediate deduction for certain eligible cleanup costs. The deduction applies to amounts paid or incurred for expenditures, that would otherwise be considered a capital expenditure, such as groundwater treatment facilities.
Reading a short article on the enactment of Section 198 would lead most people to believe that the treatment of environmental remediation expenditures is a settled issue. The fact is that while Section 198 sounds like a great incentive for brownfield development, numerous issues remain unsettled. Section 198 may be the first bite of the apple toward tax incentives for brownfield development, but a stronger incentive is necessary.
One of the biggest problems with section 198 is its numerous technical requirements. If one falls within the statutory requirements of Section 198, the tax treatment on environmental cleanup expenditures is clear. However, qualification under Section 198 is not as simple as it seems. For example, in 2000 the Senate Finance committee narrowed the scope of Section 198, to target mostly large inner cities, effectively preventing Section 198 from having any impact on brownfield development.
Although Section 198 was enacted to encourage cleanup of contaminated sites and eliminate uncertainties regarding the appropriate tax treatment of environmental cleanup costs, it has fallen short of its goal. In order to really encourage cleanups, Section 198 should be expanded in both time frame and geographic locations.
Anyone who incurs environmental remediation expenses should be allowed to deduct the costs in the year incurred. There are many advantages of such a broad provision. First, this method would provide a clear answer to the treatment of remediation costs and would eliminate the need to interpret and apply varis, ordinary business expenses can bous inappropriate rulings. Second, decisions over where to cleanup, who does the cleanup, and when the cleanup takes place would not be influenced by tax planning implications. The tax consequences would be the same regardless of who incurred such costs. Third, a strong straightforward tax incentive to cleanup contaminated sites would exist.
The major concern of such a broad based tax incentive is the loss of tax revenue. As with any tax expenditure, revenue is forgone to promote certain desired behavior. However, expanding Section 198 would result in an overall gain in tax revenue.
The ultimate goal of brownfield initiatives is to provide low cost incentives to cleanup the environment while bringing back into circulation prime areas. Tax dollars are forgone each day a brownfield lies idle. If however, brownfield sites are cleaned up and brought back into circulation, property taxes and employment taxes will be immediately generated. Investors who cleanup these sites and deduct the costs are not receiving handouts from the government. They are merely receiving an incentive for doing something they otherwise would not have done. That is, they could have located at a greenfield without incurring the cost of cleanup. Also, addressing the concern that the deduction would go to a high income individual who may get involved in a brownfields project and apply the costs against income they generated from other activities - what does it matter? As long as the environment is clean and the area is revitalized, there should not be a problem giving investors an additional incentive. In addition to allowing all individuals who remediate contaminated property at a deduction in the year the costs were incurred, the time frame for such incentive must be extended.
Tax incentives are only one method to encourage investment in brownfields. In fact the tax code may not be the best way to encourage the redevelopment of brownfields. The strongest incentive would be one which addresses the fundamental obstacles to brownfield development. Generally, the location of a brownfield, as well as its relation to existing infrastructure, makes development a promising endeavor. Also, the sites themselves are usually inexpensive, considering the size and location. Thus, economics is not the major barrier to brownfields redevelopment.
Across our nation, hundreds of thousands of contaminated sites lie idle, causing serious environmental and economic problems. Nationwide action is underway to provide incentives for the cleanup and revitalization of our nations brownfields. The benefits of redevelopment are innumerable - a cleaner environment, more jobs, increased tax base, more stable communities, and a deterrence of urban sprawl.
Enormous amounts of money are spent in the United States on the cleanup of environmentally contaminated sites. Despite nationwide action to provide incentives for redevelopment, the treatment of cleanup costs, to some extent, remains uncertain.
If an incentive is going to be offered through the IRC, all who incur remediation cost should be treated alike. While everyone could use a tax break, in the brownfield area, a tax incentive is only fair. Allowing prospective purchasers or owners who clean contaminated property to deduct such costs simply places brownfield investors on a level playing field with those who invest in greenfields, where cleanup costs are not an issue. However, if the tax incentive does not cover all environmental cleanups, then the government should use the money to combat the major obstacle to brownfield development – liability issues.