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United Dairy Farmers, Inc. v. United States

ELR Citation: 32 ELR 20120
Nos. No. 00-3800, 267 F.3d 510/(6th Cir., 10/03/2001)

The court affirms a district court holding that a dairy could not deduct soil remediation costs as ordinary business expenses under 26 U.S.C. §162 of the Internal Revenue Code. The dairy claimed that its soil remediation costs at two properties were ordinary and necessary business expenses allowing the continued use of the property, but the government claimed that the remediation resulted in permanent improvements that allowed a different use of the property and, thus, must be capitalized under 26 U.S.C. §263(a) of the Internal Revenue Code. The court first holds that the dairy failed to meet its burden of clearly showing its right to the §162 deduction. Costs that restore value to property that existed prior to deterioration or to a discrete event damaging property are deductible as repairs under §162, but costs that allow property to be used in a different way must be capitalized under §263. To determine if the dairy's properties were used in a different way, it must be determined whether the properties' condition should be evaluated at the time prior to contamination or after contamination. Although the dairy points to precedent supporting valuation prior to contamination, such precedent does not apply where a taxpayer improves property defects that were present when the taxpayer acquired the property. The remediation of such defects are capital in nature and must be addressed under §263. Because the dairy acquired the properties after they had been contaminated, valuation occurs after contamination. In addition, the dairy offered no comparisons of its property use before and after soil remediation and offered no argument that its property use after the improvements was unchanged. Moreover, large environmental cleanup costs, relative to property value, cast doubt on a taxpayer's claim of merely making incidental repairs to keep a property operating efficiently. In this case, the dairy claimed cleanup costs of nearly $260,000 for two properties that it purchased for $765,000. The court also holds that the dairy's argument that it is entitled to deduct the soil remediation expenses as bad debt expenses is waived, conceded, and meritless.

Counsel for Plaintiffs
Stephen M. Nechemias
Taft, Stettinius & Hollister
1800 Firstar Tower
425 Walnut St., Cincinnati OH 45202
(513) 381-2838

Counsel for Defendant
Thomas J. Sawyer
Tax Division
U.S. Department of Justice, Washington DC 20530
(202) 514-2000

Clay, J. Before Gilman and Wiseman,* JJ.

* The Honorable Thomas A. Wiseman Jr., United States District Judge for the Middle District of Tennessee, sitting by designation.