Raccoon City was a prosperous but small Midwestern American city that, in spite of its size sat mostly isolated in the heavily-forested Arklay Mountains. Once, Raccoon City wasn't much to look at, until Umbrella, Inc. came into the picture. Umbrella donated billions of dollars to help modernize Raccoon City, and in the process created jobs and businesses.
Before long, the American division of the international megacorporation owned over 90% of the city and had an absolute stranglehold on all governmental and law enforcement agencies there, with many public officials in their pay including the Mayor and Chief of Police. Umbrella, in helping to build the majority of the city, installed a variety of hidden research laboratories for their secret, illegal bioweapons research, the largest of which existed beneath the city itself in the outskirts.
Raccoon City was effectively doomed when in September of 1998 the T-Virus escaped from this facility and got into the sewerways, where it was spread by rats. Over half the populace was infected with the virus, turning into mindless, flesh-eating zombies. The RPD failed to contain the outbreaks of mob violence and the U.S. army quarrantined Raccoon. Eventually, after half-baked rescue operations had pulled as many survivors from the city was possible (which, sadly, amounted to less than a hundred people out of a population of thousands), the army launched a nuclear missile that obliterated Raccoon City and its undead populace.
However, six months later it was revealed that Umbrella still had plans for Raccoon City despite the fact it's now little more than a giant crater. What these plans are is yet to be revealed.
Raccoon City became infected with the T-Virus not as a result of the Cleaners breaking into the underground labs, but because of a lone vial of the virus that was thrown free of the Spencer Estate when it exploded. This vial landed in a river that existed nearby, and served to contaminate Raccoon City's water supply. Although the Cleaners did break into the underground labs for the purposes of stealing the G-Virus as in the games, Raccoon was already infested with zombies at this point. Also, this Raccoon City was never destroyed by a nuclear missile and was never quarantined by the military.
According to one account, Raccoon City was mostly destroyed in a huge fire, rather than being hit by a nuclear missile. However, a later account confirmed its nuclear destruction.
Films, Film Novelizations
Instead of one lab beneath Raccoon City and one beneath the mansion, it's merely one huge lab beneath the city, called the Hive (with the mansion being regarded as a "back door" of sorts, still existing in the woods outside the city but connected to the Hive by a train tunnel). Raccoon City becomes infected with the T-Virus when Umbrella's scientists reopen the Hive, unleashing the disease upon the city. It was "sanitized" when a nuclear missile was fired into it on the order of Major Timothy Cain after being quarrantined by Umbrella's private security forces under Cain, who constructed an enormous wall around the city in an effort to contain the infection.