Ordinary and necessary business expenses that neither materially add to the value of property nor appreciably prolong its life, but merely keep it in an ordinarily efficient working condition, may be deducted currently.Ronald A. Morris and Elliot Pisem, members of the New York bar, are partners in the law firm of Roberts & Holland LLP, New York City and Washington, D.C.

Asbestos is a hazardous substance. We have all known this since the 1970s and for the past many years asbestos has not been used in the construction of new buildings in the United States. Before the dangers posed by asbestos were fully understood, however, asbestos was used as a fire-retardant or insulating material in many buildings. Many owners of real property are now faced with the engineering, health and financial challenges of dealing with the dangers posed by asbestos installed many years ago. As owners attempt to abate those dangers, another challenge is being posed ­ the Internal Revenue Service and the courts are taking the position that, at least in some cases, the costs of abatement are not deductible for income tax purposes. On April 28, 1997, the Tax Court handed the Service a significant victory in the case of Norwest Corp. vs. Commissioner, holding that the costs of removing asbestos containing materials could not be deducted currently, but rather had to b! e capitalized, because they were part of a "general plan of rehabilitation and renovation."

As a general matter, expenditures that add to the value or substantially prolong the life of property must be capitalized. By contrast, ordinary and necessary business expenses that neither materially add to the value of property nor appreciably prolong its life, but merely keep it in an ordinarily efficient working condition, may be deducted currently. The cost of incidental repairs would normally be considered a currently deductible business expense. However, if expenses which would ordinarily be deductible as the cost of ordinary and necessary repairs are incurred a part of an overall plan of rehabilitation, they lose their deductibility.

These rules can have a peculiarly adverse (and perverse) effect on the asbestos-removal process. The danger from asbestos is greatest when the materials that contain it are disturbed and disease-causing asbestos fibers are thus released into the air. By contrast, the mere presence of undisturbed asbestos in a building is not necessarily dangerous. Thus, Norwest Corp., which had constructed an asbestos-containing building in 1969 as an operations center and branch for one of its banking subsidiaries, did nothing to abate that asbestos for many years. However, in 1985 and 1986, two distinct events occurred which changed that pattern. First, Norwest decided to consolidate its "back room" operations in the building, which necessitated a major remodeling; as a practical matter, the remodeling could not have occurred without disturbing the asbestos in place. Second, testing of asbestos levels at the building indicated that airborne asbestos levels, although not yet in excess of EPA and OSHA guidelines, were already increasing and that removal of the asbestos was for that reason warranted. Under the circumstances, Norwest decided to remove the asbestos "in coordination with the overall remodeling project." The total cost of the project during the years 1987-89 was approximately $6.9 million, of which $1.9 million was attributable to asbestos removal and $5 million was attributable to other remodeling costs.

Norwest attempted to deduct the cost of the asbestos removal for income tax purposes. The Tax Court, however, held that the cost had to be capitalized and recovered through depreciation deductions over the 31.5-year period applicable to building improvements made during the years in issue. There seem to have been two crucial facts in the Tax Court's view. First was the causal connection between the remodeling and the asbestos removal ­ the asbestos removal, which might in any event have been required at some point in the future, would not have occurred when it did had there been no remodeling project. Second, in view of the close coordination required between the asbestos removal and the remodeling work, the asbestos removal and the remodeling were "one intertwined project, entailing a full-blown general plan of rehabilitation, linked by logistical and economic concerns."

This case illustrates how not to go about asbestos abatement if it is important that the costs of abatement be currently deductible. The tax issues are somewhat different if asbestos removal is a "stand-alone" process, not connected with other capital improvements to the property. In that context, the Service has taken the position that the costs of encapsulating asbestos ­ which it has viewed, at least in some cases, as only a temporary "repair" ­ may be deductible, but the costs of removal apparently are not. You may want to consult your tax advisor as well as your environmental engineer before you take your next step!