Landlord Tax Deductions for Environmental Cleanup Costs
Learn what tax deductions landlords can take for cleaning up environmental hazards such as lead or asbestos.
It is depressingly common for landlords to discover that their property contains environmental hazards, such as lead paint, that may endanger the health of their tenants and others who visit the property. Landlords can be held legally liable for such hazards and be subjected to expensive lawsuits by injured tenants. (Landlords are also responsible for making lead disclosures to tenants.) Any decent landlord will seek to clean up (“remediate”) such hazards on rental property property. Environmental remediation can be very expensive. Obviously, it would be very helpful if a landlord could currently deduct the expense as a repair in a single year. Unfortunately, the IRS often considers such expenses to be improvements that must be depreciated over 27.5 years; or, in the case of remediation just for land, added to the tax basis of the property. See the Nolo article on repairs versus improvements for clarification of these issues.
Environmental Hazards That Occur After You Acquire the Building
Landlords are in the best position tax-wise if the environmental hazard occurs after you purchase or otherwise acquire the building. Property owners may currently deduct as a repair the cost of environmental remediation if:
- the property was in clean condition when it was acquired
- it became contaminated during the course of the property owner’s ordinary business operations
- the cleanup restores the property to its precontamination state, and
- the cleanup does not allow the owner to put the property to a new or different use. (United Dairy Farmers, Inc. v. United States, 267 F.3d 510 (6th Cir. 2001).)
Example: A company acquired a large nursing home that was free of mold when the company purchased it. However, one wing of the building later developed a severe mold problem due to roof leaks. To eliminate the mold, the property owner replaced 70% of the wall and ceiling drywall in the wing; it also removed and replaced doors, faucets, sinks, and most of the electrical fixtures. All of the old doors and sinks and most of the electrical fixtures were decontaminated and reused. The IRS ruled that the cost was a currently deductible repair, not an improvement, because the project was to restore the building to the same physical condition that existed before the onset of mold. The new materials used were of substantially similar quality as the materials that were replaced. The existing floor plan was not altered, and no structural components were repaired or replaced. The project did not substantially prolong the building’s useful life, add to its value, or adapt it to a new use. Instead, it merely kept the building in efficient operating condition. (IRS Private Letter Ruling 200607003 (2006).)
Preexisting Environmental Hazards
Environmental hazards can be present before a landlord purchases a building—for example, a landlord purchases a building that was painted with lead paint or contains asbestos. This is particularly common where the building is over 25 years old.
Historically, the IRS had held that remediation of such preexisting environmental hazards is an improvement that must be depreciated. The rationale for this rule was that the remediation does not restore the property to its original condition when purchased—rather, it makes the property more valuable and it may also prolong its useful life. For example, the IRS ruled that the cost of removing asbestos insulation in manufacturing equipment and replacing it with new insulation was an improvement. (PLR 9240004 (June 29, 1992).)
In recent years, the IRS has softened its position somewhat, ruling that a manufacturer could currently deduct the cost of removing wastes in underground storage tanks, even though the removal process required the construction of new storage tanks. (Rev. Rul. 98-25.) The IRS also permitted the cost of encapsulating exposed asbestos in a warehouse to be deducted as a repair because encapsulation left the asbestos in place, instead of removing it. (Technical Advice Memo. 94-11-002 (November 19, 1993).) But these rulings have not presaged a wholesale change in the IRS’s view as some hoped. The IRS still says that “environmental cleanup costs are generally capital expenditures”—that is, they are improvements that must be depreciated. (IRS Publication 535, Business Expenses.) Moreover, new IRS regulations provide that expenses to ameliorate a "material condition or defect" that existed before the owner purchased the property must be depreciated. This is so whether or not the owner knew about the environmental problems when the property was purchased.
Arguably, environmental remediation of hazardous substances such as lead paint or asbestos should be a repair because it usually does not add value to the property or prolong its useful life—rather, it restores lost property value due to subsequent discoveries about the dangers of exposure to such substances. In other words, the building is restored to its original condition—a building that, according to the latest health standards, is safe to use. However, neither the IRS nor the courts have accepted this argument.
For More on Lead Hazards in Housing
The section of the EPA website on lead has lots of useful articles on the subject, including lead waste and cleanup.