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Calculating the Exclusion

The calculation of the "excludable portion" of cost-share payments is based on the premise that the taxpayer is the recipient of a so-called "section 126 improvement" and that the receipt of this improvement constitutes a taxable event. The recipients gross income is increased by the value of the section 126 improvement, minus the taxpayers share of the cost of the improvement, minus the excludable portion of the cost (if any), plus any rental payments and payments for services provided by the recipient.

NOTE: For an easy to use form to help you calculate the amount of the "cost-share" payment that can be excluded from gross income click here.

The steps to determine the excludable portion of a cost-share payment are:

1. Determine the "Section 126 cost":

Cost of the improvement, which is the sum of amounts paid by the taxpayer and the government

less

Any government payments under a program which is not listed in Sec. 126(a) of the Internal Revenue Code.

less

Any portion of a government payment under a program which is listed in section 126(a) which the Secretary of Agriculture has not certified is primarily for the purposes of conservation.

less

Any government payment to the taxpayer which is in the nature of rent or compensation for services.

2. Determine the value of the section 126 improvement:

"Value of the section 126 improvement" means the fair market value of the improvement multiplied by a fraction, the numerator of which is the "section 126 cost" and the denominator of which is the cost of the improvement.

Fair market value of improvement x (section 126 cost)/(cost of improvement)

The fair market value of the improvement is the amount by which the fair market value of the portion of the property improved is increased by the improvement.

3. Determine the excludable portion of the cost:

"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.

The present value is determined by dividing the greater of the two (either 10 percent of average annual income or $2.50 times the affected acres) by "i", where "i" is an appropriate discount rate for ling-term investments. To determine the appropriate discount rate for your area click here.

"Prior average annual income" means the average of the gross receipts from the affected acreage for the last three taxable years preceding the taxable year in which installation of the improvement commenced.

4. Determine the amount included in gross income:

Value of the section 126 improvement

less

Taxpayer's contribution

less

Excludable portion

plus

Rent payments and amounts received for services provided by the taxpayer

NOTE: Amounts received for services provided by the taxpayer are subject to the self-employment tax. This would be the case if cost sharing payments covered the cost of labor and you provided the labor yourself.

If an election is made to exclude part or all of a cost-share payment from gross income, attach a statement to your tax return stating specifically the amount of the cost-share payment you received, the date you received it , the amount of the cost sharing payment that qualifies for exclusion, the amount you choose to exclude, and how you determined that amount.

The reforestation amortization deduction can not be claimed with respect to amounts excluded from gross income. In addition the basis of any property acquired or improved with these payments can not be adjusted to reflect the excluded amounts.

Once the excludable amount of the cost share payment has been determined the non-excludable portion must be reported as gross income. Cost share payments that are included in gross income are reported as miscellaneous income on the first page of Form 1040, or on Schedule C or F of Form 1040 depending on your particular tax status. That part of a cost-share payment included in gross income may be subject to the self-employment tax, because self-employment income generally includes all items of business income, including Government conservation cost-share program payments.