If you don’t have an underground pipeline crossing your farm, you probably know someone who does. And to meet US energy demands, construction of underground pipelines carrying natural gas and crude oil is increasing. Thousands of Cornbelt farmers and landowners are in negotiation with dozens of pipeline companies on easement issues and reparations for the damages related to pipeline construction. But once a landowner has negotiated the best deal possible, what are the resulting tax benefits and liabilities?

Most of the underground pipeline projects criss-crossing the US are under the oversight of the Federal Energy Regulatory Commission, which keeps track of projects, and must approve all aspects of the pipeline construction process. For a list of proposed nearby pipeline projects, consult FERC.

Agricultural Tax Law Specialist Gary Hoff at the University of Illinois says the negotiators for the pipelines will typically approach landowners to offer a financial package that includes several issues:
1) An easement to allow the company permanent access to its pipeline as it traverses your property. The easement may be on the order of 25 feet on either side of the pipeline, which gives the pipeline personnel access to repair or test the line and otherwise be on your property within that 50 foot span.
2) A work easement that may be wider than the permanent easement and wide enough to allow construction workers to operate and park vehicles, pile topsoil and subsoil, and temporarily lay pipe before it is placed into the trench for welding.
3) Crop damage within the work easement resulting from the construction, if growing crops were destroyed or damaged when the pipeline was laid.
4) Crop yield damage for several years within the construction zone where soil was disturbed.

Hoff says some of the payments are going to capital and some will be operational, and because of that they will be treated differently by the Internal Revenue Service.

Easement payments are treated by the IRS as a sale of land, and because the easement will be based on so many feet through your property by so many feet across, an acreage calculation will have to be made. Essentially, those acres are being sold for the price paid for the easement, and it could be a substantial number of dollars per acre. When you subtract your basis in the farmland from the price paid per acre by the pipeline company, the IRS requires the capital gain be reported from the sale of the easement. With the necessary adjustments for depreciation of improvements, Hoff says the capital gain would be reported on Form 4797, Sale of Business Property.

Sometimes an easement will reduce the value of the property; particularly if the farm were ripe for housing or commercial development and the pipeline easement interfered with the development. With the proper appraisal, the basis in the property could be reduced and that would change the capital gains tax liability.

Regarding other payments received from the pipeline company, Hoff says they should be itemized because they fall into different categories for tax liability:

1) Temporary easement: rental payments reportable as supplemental income on Schedule F.
2) Crop damage payments: crop income reportable as profit from farming on Schedule F.

In crop share leases, the crop damage payments would be split between operator and landowner and reported on Form 4835 Farm rental income for the landowner. In cash rent leases, crop damage and yield reduction payments would go to the operator and reported on Schedule F as profits from farming.

Summary:
Numerous farm operators and landowners throughout the Cornbelt may be impacted by the expansion of pipelines carrying energy commodities, as construction crews cut swaths through growing crops and disrupt strips of topsoil. Compensation is typically offered for both the purchase of easements, which is treated as a capital gains tax liability, as well as crop damages and yield losses which are reported on IRS Schedule F forms. Landowners and operators should carefully breakout the various payments from a pipeline company to ensure they are correctly addressed.