If you received cost share payments to cover a portion of the expenses of a reforestation project and the expenditures qualify for the reforestation deduction or amortization you will most likely be better off by including the cost share payments in your ordinary income. This allows you to claim the reforestation deduction or amortization deduction (and investment credit for expenditures on or before October 22, 2004) on your total qualified reforestation expenses, up to the $10,000 annual limit for the deduction, or pre-October 23, 2004 amortization. It also avoids having to deal with the very complicated exclusion provisions of Section 126 of the Internal Revenue Code. However, if you are in one of the higher tax brackets you may be better off excluding the cost share payments to the extent allowable. The only way to be certain is to calculate your tax liability both ways.
In general cost share payments must be reported as part of your gross income unless a specific exclusion is provided by law. Under Section 126 of the Internal Revenue Code payments made under certain state and local cost-share programs qualify for exclusion.
To learn more about specific cost-share programs click here!
NOTE:A recent Revenue Ruling (Rev. Rul 2006-46) has determined that payments received under the Conservation Security Program (CSP) are eligible for Section 126 exclusion. CSP is a voluntary program that provides financial and technical assistance to promote the conservation and improvement of soil, water, air, energy, plant and animal life, and other conservation purposes on Tribal and private working lands. The IRS has determined that all or a portion of cost-share payments received under the Conservation Security Program (CSP) is eligible for exclusion from gross income to the extent permitted by Code Sec. 126. The IRS accepted the conclusion of the U.S. Department of Agriculture (USDA) that the CSP is a small watershed program under Code Sec. 126(a)(9) that is substantially similar to the type of programs described in Code Sec. 126(a)(1) through (8).
Based on Section 126 there are two ways to report cost-share payments for Federal Income Tax purposes:
Exclude all or part of the cost share-payment from gross income. This election might be appropriate if the property will be disposed of shortly and the taxpayer wants to avoid ordinary income recapture.
Include the cost share payment in your income.
Expenses that can be deducted in full in the year in which they are incurred, and for which cost-share payments are available should usually be included as part of your gross income. Timber stand improvement (TSI) is an example of a practice for which cost-share payments are available and the cost of which is usually deductible as a current operating expense. In such cases, the cost-share payment is reported as ordinary income and the full cost of the TSI is deducted as an operating expense, creating a wash for tax purposes.
For investors the wash will be complete only if non-timber miscellaneous itemized deductions are at least 2 percent of adjusted gross income. For further details refer to the section on Investment Expenses.
To learn how to determine the excludable portion of cost-share payments click here!