Expensing of Environmental Remediation Costs About to Expire

By Robert Drury, CPA

The Grand Junction metropolitan area is the fifth largest metro area in Colorado, 12th fastest growing in the Southwest and 38th in the nation with a growth rate of 2.48% per annum, or 24.8% over the last ten years. Grand Junction's key economic strength is its economic diversity, as evidenced by the significant increase in GMP (Gross Metropolitan Product). Originally dominant in agriculture and mining, the area has seen strong growth in construction, health and medical services, retail, business and professional services. Recent news articles in the Grand Junction press have illustrated problems with contamination of properties being found in Grand Junction, as new business and industry seeks to relocate and renovate existing sites.

The Valley has gone through the mill tailings cleanup. This former Climax Uranium Company site located on the north bank of the Colorado River east of the 5th street bridge had 4.6 million cubic yards of residual radioactive materials moved to the Cheney disposal cell site located 17 miles southeast of Grand Junction. This removal started March 11, 1991 and was completed in 1993. Also contamination from leaking underground storage tanks was found while excavating the site where the new jail was to be built.

"Brownfields" are an ever-growing problem in our country. More than 400,000 of them blight our cities and towns from coast to coast. A brownfield is a site, or portion thereof, that has actual or perceived contamination and an active potential for redevelopment or reuse. They are usually run-down, abandoned properties and unsightly vacant lots where vibrant enterprises once were located.

Contaminants such as solvents, petroleum products and other chemicals have been discharged over time and have entered the soil and water tables. Although they are not contaminated at the acute level of Superfund sites, brownfields can require significant and costly environmental remediation.

Environmental remediation is time consuming - usually due to drawn out governmental permitting processes - and very costly. To make matters worse, until recently, federal tax law discouraged voluntary clean up by requiring these expenditures to be capitalized to the land cost as an improvement rather than expensed as a repair. This created an imposing obstacle to redevelopment.

To encourage redevelopment of these properties, Congress in 1997 enacted code section 198 to make expensing of environmental remediation costs allowable in the existing 31 empowerment zones. These empowerment zones were established in 1993 and 1997 and focused on urban areas. Investment by businesses within these zones qualifies for an array of special tax relief provisions. Many felt that this provision was a good start but did not go far enough to have the desired effect. There were many properties that were mildly contaminated and sitting idle. Many were in prime locations and were languishing in a state of decay and disrepair; but obviously could be used in a more productive manner. Putting these sites back into productive use will generate tax revenues, jobs, and housing, particularly in the Grand Junction Grand Valley area which is proactively attempting to create the optimal business environment to attract new growth and new business opportunities.

The 2000 Community Renewal Act expanded code Section 198 allowing for immediate deduction of qualified environmental remediation expenses to all parts of the country. This provision is effective for cleanup expenses paid or incurred after December 21, 2000, which was the date of enactment. However, as is the growing trend in Congress with tax relief measures, this provision is not permanent. It is scheduled to expire January 1, 2004. Eligible expenditures must be paid or incurred by December 31, 2003. As with any expiring tax provisions, there is support to extend it; whether it will be extended or left to expire will be at the whim of Congress.

There is very little time to still act if you want to deduct these environmental remediation expenses. If you are a cash basis taxpayer then these clean up expenses have to be paid by December 31, 2003. If you are an accrual basis taxpayer then the clean up expenses have to be incurred by December 31, 2003. To be incurred, the work has to have been actually performed, not just billed for future services.

The specifics of Code Section 198 are that in general the taxpayer may elect to treat any qualified remediation expenditure that is paid or incurred as an expense. A qualified expenditure is an expenditure otherwise chargeable to the capital account, and paid or incurred in connection with the abatement or control of "hazardous substances" at a "qualified contaminated site." A "qualified contaminated site" refers to any area that is held by the taxpayer for use in a trade or business, for the production of income, or as stock in trade or inventory; and at or on which there has been a release (or threat of release) or disposal of any hazardous substance.

In order to satisfy the requirement that there has been a release or threat of release at the site, a taxpayer must obtain a statement from the environmental agency of the state confirming the requirement has been met. In Colorado, contact the Colorado Department of Public Health and Environment - Hazardous Materials and Waste Management Division 4300 Cherry Creek Drive South, Denver , CO 80246-1530. Phone (303) 692-3398, Fax: (303) 759-5355.

Recapture of expense deductions is treated as ordinary income. For property where environmental remediation costs have been expensed under Code Section 198, upon the sale of the property, gain to the extent of cleanup costs deducted is treated as ordinary income. This provision is similar to depreciation recapture.

The EPA also has three programs under its Brownfields Economic Initiative that is designed to empower states, communities, and other stakeholders in economic redevelopment to work together in a timely manner to prevent, assess, safely clean up and sustainably reuse brownfields. There is an Assessment Demonstration Pilot Program to assess brownfield sites and to test cleanup and redevelopment models; a Job Training Pilot Program to provide training for residents of communities affected by brownfields to facilitate cleanup of brownfield sites and prepare trainees for future employment in the environmental field; and a Cleanup Revolving Fund to capitalize loan funds to make loans for the environmental cleanup of brownfields.

On the Western Slope the Peanut Mine, Inc., located a mile from Crested Butte, was selected to receive a brownfield cleanup grant. The site is one of many abandoned hard rock and coal mines that sustained the local economy until the mid 1970s. Wages in the area have only increased four percent in the past ten years. Following cleanup, land-use plans call for the creation of a trail, recreational activities, wildlife habitat and grazing land. The project is expected to help diversify and stimulate the economy by contributing to nordic skiing opportunities in the area. Cleanup will also help prevent contamination of the Slate River.

Robert Drury is a tax partner at the Grand Junction office of Gordon, Hughes & Banks, LLP. He can be reached at (970) 245-5181, or (877) 882-9853 toll free. This article appeared in the September 17, 2003 issue of the Colorado Real Estate Journal.