Florida’s Water Crises: Can We Afford The Solutions? (Part II)

With the renewed focus on water projects due to discharges from Lake Okeechobee and a recent surge in blue/green algae, there is also a renewed effort to involve private interests in the development of these projects. This series of articles addresses exceptions to the general rule that government payments received by private landowners as a part of water projects are included in gross income.[1] In our first article, we explored the opportunities afforded by § 118 for corporations. This article will address an exception potentially applicable to all taxpayers.

Section 126(a) provides a list of several federal and state subsidy payments that are excluded from gross income if and to the extent they (1) are “made primarily for the purpose of conserving soil and water resources, protecting or restoring the environment, improving forests, or providing a habitat for wildlife,” as determined by the Secretary of Agriculture[2]; (2) do not substantially increase the annual income derived from the property, as determined by the IRS; and (3) are for capital improvement(s)[3]. No deduction or credit is allowable for expenditures financed by these excludable subsidies, and such expenses cannot be included in the basis of the benefited property.[4] Section 126 is an optional provision requiring affirmative election by the taxpayer.

The Natural Resources Conservation Service (NRCS) provided public notice in 2006 that the Secretary of Agriculture determined cost-share payments made under specific State of Florida conservation programs are primarily for the purpose of conserving soil and water resources or protecting and restoring the environment and issued a similar public notice in 2009 for cost-share payments made under the State of Florida’s Agricultural Best Management Practices Program. It has been several years since these determinations were made, and the opportunity exists for expansion of these determinations to new types of water projects in Florida.

The amount of income realized by a taxpayer upon receipt of a payment that qualifies for § 126 is equal to the value of the improvement[5] less the sum of (1) the excludable portion under § 126 and (2) the taxpayer’s share of the cost of the improvement.[6] In the terms of § 126, “payment” means payment of an economic benefit to the taxpayer upon receipt of an improvement.[7]

Assuming all of the payments are primarily for the conservation purposes described above and no portion of the payment is for rent or compensation,[8] the amount included in gross income hinges on the determination of the “excludable portion” of a payment.

“Excludable portion” means “the present fair market value of the right to receive annual income from the affected acreage of the greater of 10 percent of the prior average annual income from the affected acreage or $2.50 times the number of affected acres.”[9] “Prior average annual income” means the average gross receipts from the affected acreage for the last three taxable years preceding the taxable year in which installation of the improvement began.[10] The regulations provide examples of the application of these rules, which are beyond the scope of this article but are well worth reviewing.

Although § 126 is a potential boon, it is not without pitfalls. On a sale or other disposition of property acquired, improved, or otherwise modified by expenditures financed with the excluded § 126 payments, § 1255 requires recapture of these amounts on a sliding scale, subject to rules similar to those applicable to § 1245 depreciation recapture. Gain on the disposition is ordinary income up to the amount of the § 126 exclusion, over a twenty year time period reduced by 10% for every year in excess of ten years that the taxpayer held the property following receipt of the excluded amount. This trap for the unwary could put the taxpayer in a less favorable position than would have been obtained without § 126.

The decision to elect to utilize § 126 requires careful planning, but with current designations of qualifying projects and future expansion opportunities to include additional water projects, § 126 should prove to be a very useful tool in this effort. The next and last article in this series will address some creative opportunities available through the use of conservation easements and certain exchange transactions.

About the Authors:
Dana M. Apfelbaum practices in the areas of federal income, estate, and gift tax law and family business succession planning. She counsels individuals in estate planning, with an emphasis on implementing the client’s objectives, asset protection and minimizing wealth transfer taxes. Ms. Apfelbaum also represents fiduciaries through all stages of probate, estate and trust administration. In addition, she represents businesses and business owners in all types of business and tax matters, including choice of entity, mergers and acquisitions, reorganizations, other general business matters, and succession planning. She may be reached at dapfelbaum@www.deanmead.com.

Brad Gould practices in Dean Mead’s Fort Pierce office located in St. Lucie County, Florida. His practice covers the areas of federal income, estate, and gift tax law and business succession planning.  He represents businesses and business owners in all types of business and tax matters, including choice of entity, mergers and acquisitions, reorganizations, and other general business matters.  Mr. Gould represents individuals, businesses and fiduciaries before the IRS and also counsels clients on estate and wealth preservation planning matters.  Additionally, he represents trustees, personal representatives and family members in controversies regarding wills, trusts and estates.  Mr. Gould is a Certified Public Accountant. He may be reached at bgould@www.deanmead.com.

Michael D. Minton is a shareholder and chair of Dean Mead’s Agribusiness Industry Team. He represents family businesses with an emphasis on generationally owned agricultural businesses. Mr. Minton assists with their organizational structure, federal income, estate and gift tax planning, and business succession planning. He is a member of the Solutions Committee of the Central Florida Water Initiative. He may be reached at (772) 464-7700 or by email at mminton@www.deanmead.com.


[1] IRS §61(a); Rev. Rul. 60-32; Notice 99-3, 1999-1 CB 271; Notice 2006-108, 2006-2 CB 1118; All statutory references to the Internal Revenue Code of 1986 (IRC).

[2] IRC §§ 126(a)(1) through 126(a)(8) lists eight specific federal programs, and IRC § 126(a)(9) includes “any small watershed program administered by the Secretary of Agriculture” that the IRS determines “to be substantially similar to the type of programs described in paragraphs (1) through (8).

[3] Temp. Reg. § 16A.126-1(a).

[4]  IRC §§ 126(d), 126(e).

[5] Defined in Temp. Reg. § 16A.126-1(b)(3).

[6] Temp. Reg. § 16A.126-1(a).

[7] Temp. Reg. § 16A.126-1(a).

[8] Any amount paid as rent or compensation is ineligible for IRC § 126 exclusion.  Temp. Reg. § 16A.126-1(b)(2)(iii).

[9] Temp. Reg. § 16A.126-1(b)(5).

[10] Temp. Reg. § 16A.126-1(b)(6).