26 CFR Part 16A — Temporary Income Tax Regulations Relating to the Partial Exclusion for Certain Conservation Cost-Sharing Payments

PART 16A—TEMPORARY INCOME TAX REGULATIONS RELATING TO THE PARTIAL EXCLUSION FOR CERTAIN CONSERVATION COST-SHARING PAYMENTS Authority: Secs. 126 and 7805 of the Internal Revenue Code of 1954 (92 Stat. 2888, 26 U.S.C. 126; 68A Stat. 917, 26 U.S.C. 7805). Source: T.D. 7778, 46 FR 27637, May 21, 1981, unless otherwise noted. § 16A.126-0 Effective dates. These temporary regulations shall apply to any payments received under a contract signed by the taxpayer and the appropriate agency after September 30, 1979. § 16A.126-1 Certain cost-sharing payments—in general. (a) Introduction. (b) Definitions. (1) “Cost of the improvement” means the sum of amounts paid by a government and the taxpayer, whether or not with borrowed funds, for the improvement. (2) “Section 126 cost” means the cost of the improvement less the sum of (i) Any government payments under a program which is not listed in section 126(a), (ii) 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 purposes of conservation, (iii) Any government payment to the taxpayer which is in the nature of rent or compensation for services. (3) “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. (4) “Affected acreage” means the acres affected by the improvement. (5) “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. (6) “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 is commenced. (7) “Section 126 improvement” means the portion of the improvement equal to the percentage which government payments made to the taxpayer, which the Secretary of Agriculture has certified were made primarily for the purpose of conservation, bear to the cost of the improvement. (c) Income realized upon receipt of a section 126 improvement Section 126 exclusion applied. (2) Section 126 exclusion not applied. (d) Payments under watershed programs Programs within section 126(a)(9). These programs must be administered by the Secretary of Agriculture and be determined by the Commissioner to be substantially similar to the type of program described in section 126(a) (1) through (8). The Commissioner has determined that section 126 improvements made in connection with small watersheds are within the scope of section 126(a)(9) if they are made under one of the following programs: (A) The Watershed Protection and Flood Prevention Act, Pub. L. 566, 68 Stat. 666, as amended (16 U.S.C. 1001, et seq. (B) Flood Prevention Projects, Pub. L. 86-468, sec. 1, 74 Stat. 131, as amended (16 U.S.C. 1006a); Pub. L. 78-534, sec. 2, 58 Stat. 889 (33 U.S.C. 701a-1); Pub. L. 78-534, sec. 13, 58 Stat. 905; (C) Emergency Watershed Protection, Pub. L. 81-516, sec. 216, 64 Stat. 184 (33 U.S.C. 701b-1), and (D) Colorado River Basin Salinity Control Act, Pub. L. 93-320, 88 Stat. 266: ( 1 ( 2 (2) Other programs. (3) Small watershed defined. (e) Basis of property not increased by reason of excludable amounts. (f) Cross reference. (g) Examples. Example (1). In 1981, 100 acres of the taxpayer's land is reclaimed under a Rural Abandoned Mine Program contract with the Soil Conservation Service of the U.S. Department of Agriculture. The total cost of the improvement is $700,000. USDA pays $690,000, the taxpayer $10,000. The Secretary of Agriculture certifies that 95% of the $690,000 USDA payment was primarily for the purpose of conservation. Therefore, $34,500 ($690,000 × .05) is a nonsection 126 payment. $150,000 of USDA's payment is compensation for the taxpayer's service in the reclamation project and is includable in gross income as compensation for services. The taxpayer has $20,000 of allowable deductions in 1981, $15,500 of which are properly attributable to the USDA payment. Based on all the facts and circumstances, the value of the improvement is $21,000. The taxpayer elects not to have section 126 apply. The taxpayer computes the amount which is included in gross income as a result of receipt of the improvement as follows: (1) Cost of improvement $700,000 Nonsection 126 payment (34,500) Compensation for services (150,000) Current deductions (15,500) Section 126 cost 500,000 (2) Value of improvement 21,000 Multiplied by section 126 cost × 500,000 Cost of improvement 700,000 Value of section 126 improvement 15,000 (3) Value of section 126 improvement 15,000 (Taxpayer's contribution) 10,000 Amount included in gross income 5,000 Example (2). The facts are the same as example (1) except that section 126 applies. Based on all the facts and circumstances, the present fair market value of the right to receive annual income from the property of 10 percent of the prior average annual income of the affected acreage prior to the receipt of the improvement is $1,380 and the present fair market value of the right to receive $250 ($2.50 × 100 acres) is $1,550. The excludable portion is, therefore, $1,550. The taxpayer computes the amount included in gross income as follows: Value of section 126 improvement $15,000 (Taxpayer's contribution) (10,000) (Excludable portion) (1,550) Amount included in income 3,450 Example (3). The facts are the same as example (2) except that the present value of 10 percent of the prior average annual income is $5,600. The taxpayer realizes no income as a result of receipt of the section 126 project. (1) Value of section 126 improvement $15,000 (Taxpayer's contribution) (10,000) (Excludable portion) (5,600) Amount included in income 0 Example (4). In 1983, the taxpayer signs a contract under the water bank program under which he will maintain 20 acres of undisturbed wetlands as a wildfowl preserve. In return he will receive $90 an acre as rent from the government. Although the payment is made under a program listed in section 126(a) and the Secretary of Agriculture has certified that the entire amount of payment was made primarily for the purpose of conservation, there is no income eligible for section 126 exclusion because the full payment is rent. The rent is included in full in gross income. Example (5). In 1980, the taxpayer reforests 200 acres of nonindustrial private forest land by planting tree seedlings. The taxpayer pays the full cost of the reforestation, $15,000. Under the cost-sharing provisions of the forestry incentives program, the taxpayer receives a reimbursement from USDA of $12,000. The Secretary of Agriculture certifies that 100% of the USDA payment is primarily for the purpose of conservation. Assume that the excludable portion is $3,500 and that based on all the facts and circumstances, the value of the improvement is $15,000. The amount which is includable in income is the value of the section 126 improvement, reduced by the excludable portion and the taxpayer's share of the cost of the improvement. Therefore the taxpayer includes $8,500 in gross income as a result of the USDA payment, computed as follows: Value of the section 126 improvement $15,000 (Excludable portion) (3,500) (Taxpayer's contribution) (3,000) Amount included in gross income 8,500 [T.D. 7748, 46 FR 27637, May 21, 1981; 46 FR 41043, Aug. 14, 1981] § 16A.126-2 Section 126 elections. (a) Election for section 126 not to apply in whole or in part. (b) Application of the section 126 exclusion. § 16A.1255-1 General rule for treatment of gain from disposition of section 126 property. (a) Ordinary income General rule. (i) The “excludable portion” under section 126, or (ii)(A) The excess of the amount realized (in the case of a sale, exchange, or involuntary conversion), or the fair market value of the section 126 property (in the case of any other disposi-tion), over the adjusted basis of the property, less (B) The amount recognized as ordinary income under the other provisions of Chapter I, Subchapter P, Part IV of the Code. (2) Application of section. (3) Meaning of terms. (i) The term “section 126 property” means any property acquired, improved, or otherwise modified as a result of a payment listed in section 126(a) which has been certified by the Secretary of Agriculture as primarily for the purpose of conservation; (ii) The term “excludable portion” is defined in § 16A.126-1(b)(5); (iii) The term “disposition” has the same meaning as in § 1.1245-1(a)(3); (iv) The term “date of receipt of the section 126 payment” means the last date the government made a payment for the improvements. (4) Applicable percentage. (5) Portion of parcel. (b) Instances of nonapplication In general. (2) Losses. (c) Relation of section 1255 to other provisions General. (2) Nonrecognition sections overridden. (3) Installment method. (4) Exempt income. (5) Treatment of gain not recognized under section 1255(a)(1). (d) Example. Example. Individual A uses the calendar year as his taxable year. On April 10, 1995, A sells for $75,000 section 126 property with an adjusted basis of $52,500 for a realized gain of $22,500. The excludable portion under section 126 was $18,000. A received the section 126 payment on January 5, 1990. No gain is recognized as ordinary gain under sections 1231 through 1254. Because the applicable percentage, 100 percent, of the aggregate of the section 126 improvements ($18,000), $18,000, is lower than the gain realized, $22,500, the amount of gain recognized as ordinary income under section 1255(a)(1) is $18,000. The remaining $4,500 of the gain may be treated as gain from the sale or exchange of property described in section 1231. § 16A.1255-2 Special rules. (a) Exception for gifts General rule. (2) Disposition in part a sale or exchange and in part a gift. (3) Treatment of section 126 property in hands of transferee. (4) Examples. Example (1). On March 2, 1986, A makes a gift to B of a parcel of land having an adjusted basis of $40,000 and fair market value of $65,000. On the date of that gift, the aggregate of excludable portions under section 126 was $24,000. The section 126 payments were all received on January 15, 1981. Upon making the gift, A recognizes no gain under section 1255(a)(1). See paragraph (a)(1) of this section. For treatment of the property in the hands of B, see example (1) of paragraph (d)(3) of this section. Example (2). (i) Assume the same facts as in example (1), except that A transfers the land to B for $50,000. Assume further that no gain is recognized as ordinary income under any other provision of Chapter I, Subchapter P, Part IV of the Code. Thus, the gain realized is $10,000 (amount realized, $50,000, minus adjusted basis, $40,000), and A has made a gift of $15,000 (fair market value, $65,000, minus amount realized, $50,000). (ii) Upon the transfer of the land to B, A recognizes $10,000 as ordinary income under section 1255(a)(1), computed under paragraph (a)(2) of this section as follows: (1) Aggregate of excludable portions under section 126 $24,000 (2) Multiply: Applicable percentage for land disposed if within sixth year after section 126 payments were received 100 (3) Amount in § 16A.1255-1(a)(1)(i) $24,000 (4) Gain realized (see (i) of this example) 10,000 (5) Amount in § 16A.1255-1(a)(1)(ii) applied in accordance with paragraph (a)(2) of this section 10,000 (6) Lower of line (3) or line (5) 10,000 Thus, the entire gain realized on the transfer, $10,000, is recognized as ordinary income. For treatment of the farm land in the hands of B, see example (2) of paragraph (d)(3) of this section. (b) Exception for transfer at death In general. (2) Treatment of section 126 property in hands of transferee. (c) Limitation for certain tax-free transactions Limitation on amount of gain. (2) Transfers covered. (i) Section 332 (relating to distributions in complete liquidation of an 80-percent-or-more controlled subsidiary corporation). For application of paragraph (c)(1) of this section to such a complete liquidation, the principles of § 1.1245-4(c)(3) shall apply. Thus, for example, the provisions of paragraph (c)(1) of this section do not apply to a liquidating distribution of section 126 property by an 80-percent-or-more controlled subsidiary to its parent if the parent's basis for the property is determined, under section 334(b)(2), by reference to its basis for the stock of the subsidiary. (ii) Section 351 (relating to transfer to a corporation controlled by the transferor). (iii) Section 361 (relating to exchanges pursuant to certain corporate reorganizations). (iv) Section 371(a) (relating to exchanges pursuant to certain receivership and bankruptcy proceedings). (v) Section 374(a) (relating to exchanges pursuant to certain railroad reorganizations). (vi) Section 721 (relating to transfers to a partnership in exchange for a partnership interest). See paragraph (e) of this section. (vii) Section 731 (relating to distributions by a partnership to a partner). For special carryover of basis rule, see paragraph (e) of this section. (viii) Section 1031 (relating to like kind exchanges). (ix) Section 1034 (relating to rollover of gain on the sale of a principal residence). (3) Treatment of section 126 property in the hands of transferee. (4) Examples. Example (1). On January 4, 1986, A holds a parcel of property that is section 126 property having an adjusted basis of $15,000 and a fair market value of $40,000. On that date he transfers the parcel to corporation M in exchange for stock in the corporation worth $40,000 in a transaction qualifying under section 351. On the date of the transfer, the aggregate of excludable portions under section 126 with respect to the transferred property is $18,000 and all of such amount was received on March 25, 1981. With regard to section 1255, A would recognize no gain under section 351 upon the transfer and M's basis for the land would be determined under section 362(a) by reference to its basis in the hands of A. Thus, as a result of the disposition, no gain is recognized as ordinary income under section 1255 by A since the amount of gain recognized under that section is limited to the amount of gain which is recognized under section 351 (determined without regard to section 1255). See paragraph (c)(1) of this section. For treatment of the section 126 property in the hands of B, see paragraph (d)(1) of this section. Example (2). Assume the same facts in example (1), except that A transferred the property to M for stock in the corporation worth $32,000 and $8,000 cash. The gain realized is $25,000 (amount realized, $40,000, minus adjusted basis, $15,000). Without regard to section 1255, A would recognize $8,000 of gain under section 351(b). Assume further that no gain is recognized as ordinary income under the other provisions of Chapter I, Subchapter P, Part IV of the Code. Therefore, since the applicable percentage, 100 percent of the aggregate excludable portions under section 126, $18,000, is lower than the gain realized, $25,000, the amount of gain to be recognized as ordinary income under section 1255(a)(1) would be $18,000 if the provisions of paragraph (c)(1) of this section do not apply. Since under section 351(b) gain in the amount of $8,000 would be recognized to the transferor without regard to section 1255, the limitation provided in paragraph (c)(1) of this section limits the gain taken into account by A under section 1255(a)(1) to $8,000. Example (3). Assume the same facts as in example (2), except that $5,000 of gain is recognized as ordinary income under section 1251(c)(1). The amount of gain recognized as ordinary income under section 1255(a)(1) is $3,000 computed as follows: (1) Amount of gain under section 1255(a)(1) (determined without regard to paragraph (c)(1) of this section): (a) Aggregate of excludable portions under section 126 $18,000 (b) Multiply: Applicable percentage for property disposed of within the fifth year after section 126 payments were received (percent) 100 (c) Amount in § 16A.1255-1(a)(1)(i) $18,000 (d) Gain realized (amount realized $40,000 less adjusted basis, $15,000) $25,000 (e) Lower of line (c) or line (d) $18,000 (2) Limitation in paragraph (c)(1) of this section: (a) Gain recognized (determined without regard to section 1255) $8,000 (b) Minus: Gain recognized as ordinary income under section 1251(c)(1) $5,000 (c) Difference $3,000 (3) Lower of line (1)(e) or line (2)(c) $3,000 Thus, the entire gain recognized under section 351(b) (determined without regard to sections 1251 and 1255), $8,000, is recognized as ordinary income since that amount is equal to the sum of the gain recognized as ordinary income under section 1251(c)(1), $5,000, and under section 1255(a)(1), $3,000. (d) Treatment of section 126 property received by a transferee in a disposition by gift and certain tax-free transactions General rule. (i) The aggregate of the excludable portions under section 126 in respect of the land in the hands of the transferee immediately after the disposition shall be an amount equal to the amount of such aggregate in the hands of the transferor immediately before the disposition, and (ii) For purposes of applying section 1255 upon a subsequent disposition by the transferee (including a computation of the applicable percentage), the dates of receipt of section 126 payments shall not be affected by the dispositions. (2) Certain partially tax-free transfers. (3) Examples. Example (1). Assume the same facts as in example (1) of paragraph (a)(4) of this section. Therefore, on the date B receives the land in the gift transaction, under paragraph (d)(1) of this section the aggregate of excludable portions under section 126 in respect of the land in the hands of B is the amount in the hands of A, $24,000, and for purposes of applying section 1255 upon a subsequent disposition by B (including a computation of the applicable percentage) the date the section 126 payments were received is the same as it was when the property was in A's hands (January 15, 1981). Example (2). Assume the same facts as in example (2) of paragraph (a)(4) of this section. Under paragraph (d)(2) of this section, the aggregate of excludable portions under section 126 which pass over to B for purposes of section 1255 is $14,000 ($24,000 excluded under section 126 minus $10,000 gain recognized under section 1255(d)(1) in accordance with example (2) of paragraph (a)(4) of this section). The date the section 126 payments were received is the same as when the property was in B's hands (January 15, 1981). (e) Disposition of section 126 property not specifically covered.

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