Cost-Sharing Exclusion (Improvements): Farm Business Taxes (2025 IRS Guide)

This guide covers “Cost-Sharing Exclusion (Improvements)” within farm business taxes. The following material presents the IRS treatment of this topic, including the qualifications, exceptions, and examples in the source section. Read the rules alongside the facts of your own situation before deciding what to report, deduct, or document.

Adapted from Publication 225 (2025), Farmer's Tax Guide, published by the Internal Revenue Service. This guide retains the source edition’s years, amounts, deadlines, and examples. It is guidance for that edition, not a statement that the same figures apply to every tax year.

Context for these rules

You must include in income most government payments, such as those for approved conservation practices, livestock indemnity payments, or livestock forage disaster payments whether you receive them in cash, materials, services, or commodity certificates. However, you can exclude from income some payments you receive under certain cost-sharing conservation programs if there is a corresponding reduction in basis of a related improvement. See Cost-Sharing Exclusion (Improvements), later.

Report the agricultural program payment on the appropriate line of Schedule F, Part I. Report the full amount even if you return a government check for cancellation, refund any of the payment you receive, or the government collects all or part of the payment from you by reducing the amount of some other payment or Market Assistance Loans (MALs). However, you can deduct the amount you refund or return or that reduces some other payment or loan to you. Claim the deduction on Schedule F, Part II, for the year of repayment or reduction.

Cost-Sharing Exclusion (Improvements)

You can exclude from your income part or all of a payment you receive under certain federal or state cost-sharing conservation, reclamation, and restoration programs. However, see Effects of the exclusion, later. A payment is any economic benefit you get as a result of an improvement. However, this exclusion applies only to that part of a payment that meets all three of the following tests.

1. It was for a capital expense. You can’t exclude any part of a payment for an expense you can deduct in the year you pay or incur it. You must include the payment for a deductible expense in income, and you can take any offsetting deduction. See chapter 5 for information on deducting soil and water conservation expenses.

2. It doesn’t substantially increase your annual income from the property for which it’s made. An increase in annual income is substantial if it’s more than the greater of the following amounts.

   1. 10% of the average annual income derived from the affected property before receiving the improvement.

   2. $2.50 times the number of affected acres.

3. The Secretary of Agriculture certified that the payment was primarily made for conserving soil and water resources, protecting or restoring the environment, improving forests, or providing a habitat for wildlife.

Qualifying programs.

If the three tests listed above are met, you can exclude part or all of the payments from the following programs.

• The rural clean water program authorized by the Federal Water Pollution Control Act.

• The rural abandoned mine program authorized by the Surface Mining Control and Reclamation Act of 1977.

• The water bank program authorized by the Water Bank Act.

• The emergency conservation measures program authorized by title IV of the Agricultural Credit Act of 1978.

• The agricultural conservation program authorized by the Soil Conservation and Domestic Allotment Act.

• The great plains conservation program authorized by the Soil Conservation and Domestic Policy Act.

• The resource conservation and development program authorized by the Bankhead-Jones Farm Tenant Act and by the Soil Conservation and Domestic Allotment Act.

• Certain small watershed programs, listed later.

• Any program of a state, territory of the United States, a political subdivision of any of these, or of the District of Columbia, under which payments are made to individuals primarily for conserving soil, protecting or restoring the environment, improving forests, or providing a habitat for wildlife. Several state programs have been approved. For information about the status of those programs, contact the state offices of the Farm Service Agency (FSA) and the Natural Resources and Conservation Service (NRCS).

Small watershed programs.

If the three tests listed earlier are met, you can exclude part or all of the payments you receive under the following programs for improvements made in connection with a watershed.

• The programs under the Watershed Protection and Flood Prevention Act.

• The flood prevention projects under the Flood Control Act of 1944.

• The Emergency Watershed Protection Program under the Flood Control Act of 1950.

• Certain programs under the Colorado River Basin Salinity Control Act.

• The Wetlands Reserve Program authorized by the Food Security Act of 1985, the Federal Agriculture Improvement and Reform Act of 1996, and the Farm Security and Rural Investment Act of 2002.

• The Environmental Quality Incentives Program (EQIP) authorized by the Federal Agriculture Improvement and Reform Act of 1996.

• The Wildlife Habitat Incentives Program (WHIP) authorized by the Federal Agriculture Improvement and Reform Act of 1996.

• The Soil and Water Conservation Assistance Program authorized by the Agricultural Risk Protection Act of 2000.

• The Agricultural Management Assistance Program authorized by the Agricultural Risk Protection Act of 2000.

• The Conservation Reserve Program authorized by the Food Security Act of 1985 and the Federal Agriculture Improvement and Reform Act of 1996.

• The Forest Land Enhancement Program authorized under the Farm Security and Rural Investment Act of 2002.

• The Conservation Security Program authorized by the Food Security Act of 1985.

• The Forest Health Protection Program (FHPP) authorized by the Cooperative Forestry Assistance Act of 1978.

Income realized.

The gross income you realize upon getting an improvement under these cost-sharing programs is the value of the improvement reduced by the sum of the excludable portion and your share of the cost of the improvement (if any).

Value of the improvement.

You determine the value of the improvement by multiplying its fair market value (defined in chapter 6) by a fraction. The numerator of the fraction is the total cost of the improvement (all amounts paid either by you or by the government for the improvement) reduced by the sum of the following items.

• Any government payments under a program not listed earlier.

• Any part of a government payment under a program listed earlier that the Secretary of Agriculture hasn’t certified as primarily for conservation.

• Any government payment to you for rent or for your services.

The denominator of the fraction is the total cost of the improvement.

Excludable portion.

The excludable portion is the present fair market value of the right to receive annual income from the affected acreage of the greater of the following amounts.

1. 10% of the prior average annual income from the affected acreage. The prior average annual income is the average of the gross receipts from the affected acreage for the last 3 tax years before the tax year in which you started to install the improvement.

2. $2.50 times the number of affected acres.

.The calculation of present fair market value of the right to receive annual income is too complex to discuss in this publication. You may need to consult your tax advisor for assistance..

Example.

One hundred acres of your land was reclaimed under a rural abandoned mine program contract with the NRCS of the USDA. The total cost of the improvement was $500,000. The USDA paid $490,000. You paid $10,000. The value of the cost-sharing improvement is $15,000.

The present fair market value of the right to receive the annual income described in (1) above was calculated to be $1,380, and the present fair market value of the right to receive the annual income described in (2) is $1,550. The excludable portion is the greater amount, $1,550.

You figure the amount to include in gross income as follows:

Effects of the exclusion.

When you figure the basis of property you acquire or improve using cost-sharing payments excluded from income, subtract the excluded payments from your capital costs. Any payment excluded from income isn’t part of your basis. In the example above, the increase in basis is $500,000 – $490,000 + $3,450 = $13,450.

In addition, you can’t take depreciation, amortization, or depletion deductions for the part of the cost of the property for which you receive cost-sharing payments you exclude from income.

How to report the exclusion.

Attach a statement to your tax return (or amended return) for the tax year you receive the last government payment for the improvement. The statement must include the following information.

• The dollar amount of the cost funded by the government payment.

• The value of the improvement.

• The amount you’re excluding.

Report the total cost-sharing payments you receive on Schedule F, line 4a, and the taxable amount on line 4b.

Recapture.

If you dispose of the property within 20 years after you received the excluded payments, you must treat as ordinary income part or all of the cost-sharing payments you excluded. In the above example, if the 100 acres were sold within 20 years of the exclusion for a gain of $2,000, $1,550 of that amount would be included in ordinary income. You must report the recapture on Form 4797. See Section 1255 property under Other Gains in chapter 9.

Electing not to exclude payments.

You can elect not to exclude all or part of any payments you receive under these programs. If you make this election for all of these payments, none of the above restrictions and rules apply. You must make this election by the due date, including extensions, for filing your return. In the example above, an election not to exclude payments results in $5,000 included in income and a $15,000 increase in basis. If you timely filed your return for the year without making the election, you can still make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). Write “Filed pursuant to section 301.9100-2” at the top of the amended return and file it at the same address you filed the original return.

Using the guidance

Keep the documents that establish the dates, amounts, and circumstances described above. References to other chapters, forms, worksheets, or earlier and later sections refer to the linked IRS publication. Check the full publication and its updates before relying on a rule for a different tax year or a situation not addressed here.

Sources and further reading

• Publication 225 (2025), Farmer's Tax Guide: Farm Income — Agricultural Program Payments — Cost-Sharing Exclusion (Improvements) — Internal Revenue Service; 2025 edition.

The cited U.S. government text is in the public domain. Source accessed October 28, 2026. Fynoptic has organized this material for educational use and is independent of, and not endorsed by, the IRS.