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Mold: Removal is Tax Deductible
By Anthony Cilibrasi
The cost of removing mold from a building can be very substantial, sometimes requiring the replacement of most or all of the walls and ceiling drywall as well as electrical fixtures. Whether such costs are immediately deductible or must be capitalized has not been clear, but a recent private letter ruling now says that the cost to remove mold from a building is deductible as an ordinary and necessary expense under Code Section 162 (PLR200607003).
General Rule
Generally, repairs are deductible as ordinary and necessary trade or business expenses when they keep property in an ordinary and efficient operating condition. Outlays must be capitalized when the purpose is to place property in an ordinarily efficient operating condition or to add to the property’s value by prolonging its useful life or adapting it to a new or different use.
Background
The letter ruling involved a building under lease to tenants that operated a skilled nursing facility. To the best of the landlord’s knowledge, no mold was in the building when it had been purchased. At some later point, the landlord learned that due to a series of roof leaks and condensation from heating and air conditioning, a severe mold problem existed in one of the wings of the building. The landlord undertook a remediation project to remove the mold and restore the building to its physical condition prior to the existence of the mold. The landlord removed and replaced about 70 percent of wall and ceiling drywall and replaced electrical fixtures. The new materials were substantially similar in quality to the replaced materials. The floor plan of the building was not changed and no structural components were repaired or replaced.'
IRS Ruling
The IRS ruled that the costs were deductible as ordinary and necessary business expenses under Code Section 162. The use of the building was unchanged and the remediation did not increase the value of the building or appreciably prolong its useful life. However, if the mold removal had been done as part of an overall rehabilitation or renovation plan, the cost would need to be capitalized rather than deducted.
Asbestos Removal
In order to reduce the risk that higher interest rates might hurt refinancing, a mezzanine lender may protect itself by "stressing" or increasing the initial interest rate above the market rate at the time of underwriting. The amount of stress depends on the term of the loan and the current interest rate environment. Many mezzanine lenders will add 50 to 100 basis points per year. (100 basis points equals 1 percent.)
Sale Exit
In the case of asbestos in a building (the other major problem in recent years), IRS rulings have distinguished two different situations. The Service has ruled that the costs of encapsulating (i.e., covering or re-wrapping) exposed and damaged asbestos-containing pipe insulation are deductible repair costs. The reasoning is similar to that for mold because encapsulation neither materially adds to the value of property nor appreciably increases its life. On the other hand, when a property owner removes asbestos-containing material, those costs are required to be capitalized and added to the tax basis of the building. In view of the IRS, the removal results in an improvement to the property because it reduces or eliminates human health risks and so increases the property value. (The Court of Federal Claims, however, has taken a more liberal view and permitted deduction.)
Observation: The reason why the IRS does not apply the same distinction between repair and removal to mold is that removal is the only effective way to deal with mold.
Anthony Cilibrasi is a Tax Associate in BDO Seidman’s New York office. He can be reached at (212) 885-8149.
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