Brownfield Projects October 2002 Update | Norton Rose Fulbright
Companies redeveloping old industrial sites or so-called “brownfields” in the United States may be eligible for significant federal and state tax benefits on environmental remediation costs. The federal brownfields tax incentive is intended to encourage development of contaminated industrial sites. In addition, many states have enacted programs to provide tax credits or other tax benefits for developers of contaminated sites. A combination of the federal brownfields tax incentive and state tax breaks and other inducements may help reduce project development costs and improve the financials of the project.
Federal Tax Incentive
The federal brownfields tax incentive allows taxpayers to deduct immediately the cost of certain environmental remediation and redevelopment activities. It applies regardless of whether the company redeveloping the property caused the contamination or is working on a site that was contaminated by someone else. Without this provision, taxpayers would be required to capitalize most of these types of costs, which means that the costs would be added into the tax basis of the property. The taxpayer could still recover the capitalized costs, but it would do so much more slowly through depreciation deductions for the property or in the manner of a smaller taxable gain when the property is sold.
In order to qualify for the federal brownfields tax incentive, a taxpayer must incur “qualified environmental remediation expenditures” at a “qualified contaminated site.”
Three things must be true of a site for it to be considered a “qualified contaminated site.” The property must be held by the taxpayer in its trade or business or for the production of income. Property that is held as inventory for anticipated sale to customers also qualifies. This means the taxpayer cannot be developing the site for its personal use. It also means that the taxpayer must either own the site or be in possession under a long-term lease. Second, a state agency must certify either that a release of a hazardous substance has occurred or that the threat of a release exists. The list of hazardous substances is comprehensive, but some notable exceptions include petroleum, asbestos and lead paint in buildings, and naturally-occurring contaminants like radon. Finally, the property cannot be listed on — or be under consideration for — the “National Priorities List” of contaminated sites compiled by the Environmental Protection Agency pursuant to the so-called “Superfund” legislation.
A “qualified environmental remediation expenditure” is a cost incurred to control or remove a hazardous substance from a qualifying site. Costs related to site assessment and investigation generally qualify, as long as such activities are part of an overall effort to control a hazardous substance. Generally, spending on depreciable property such as the equipment used in the cleanup effort does not qualify, though there is some leeway if the equipment is dedicated to the particular site.
Additional restrictions apply to otherwise qualifying cleanup costs that were incurred prior to December 21, 2000. When originally enacted in 1997, the brownfields deduction was slated to expire at the end of 2000 and was limited to development activities in certain economically-distressed areas of the United States. Congress eventually amended the statute, extending the expiration date to December 31, 2003 and lifting all geographic restrictions. Thus, any qualifying costs incurred from December 21, 2000 to December 31, 2003 are not subject to any geographic restrictions. Costs incurred between August 5, 1997 and December 21, 2000 will be deductible only if they relate to projects in the specified economically-distressed zones.
Some environmental remediation expenditures may also be immediately deductible for another reason under another provision of the tax laws. For example, in 1994 — prior to the enactment of the specific brownfields deduction — the IRS issued guidance that listed a few types of environmental cleanup costs that could be deducted immediately as “ordinary and necessary” business expenses. That list included activities such as excavating contaminated soil, transporting the soil to disposal facilities and back-filling excavated areas with uncontaminated soils. The guidance only applies where such costs were incurred by the party who owned the property and was responsible for the damage in the first place. Costs that are immediately deductible under these rules — or any other provision of the tax law — do not qualify for the brownfields deduction.
If qualified environmental remediation expenditures are deducted pursuant to the federal brownfields tax incentive, some or all of the deductions may have to be recaptured as ordinary income when the property is sold. This means that any gain on the sale of the property will be treated as ordinary income, as opposed to capital gain, to the extent the taxpayer claimed immediate deductions for cleanup costs.
Even considering the recapture requirement, the advantages of taking an immediate deduction for remediation costs will generally provide a greater benefit than adding the costs to the tax basis of the property. However, this analysis typically involves evaluating several factors such as the taxpayer’s tax bracket, the timing of the property sale, and current and projected differences between ordinary income and capital gains tax rates.
When evaluating a potential brownfields redevelopment project, the availability of state grants and tax incentives should also be considered. A number of states have enacted brownfields tax incentive programs; however, many of these programs do not reach as far as the federal program. For example, Massachusetts enacted a brown-fields tax credit program that provides remediation tax credits ranging from 25% to 50% of the cleanup costs. The program is limited to companies that incur remediation costs at sites where the entity seeking the tax credit did not cause or contribute to the release of oil or hazardous substances and did not own or operate the site at the time of the release. The site must also be located in an “economically-distressed area” and a permanent solution or remedy must comply with the Massachusetts cleanup program requirements.
Other states that have adopted tax incentive programs include Florida (a 33% tax credit of up to $250,000 per site for voluntary brownfields cleanup costs), Illinois (an income tax credit of up to 25% for cleanup costs associated with a sites where the brownfields developer did not cause the contamination), and Ohio (tax credits of up to 10% to 15% of eligible brownfields cleanup costs that may be credited against corporate franchise and state income taxes). Many states have adopted brownfields programs that include not only tax incentives but other financial inducements such as grants and loan programs in order to revitalize distressed communities, boost tax revenue, and create new jobs.