Does your state tax personal income? If so, then while it may be tax exempt for state taxes, I seriously doubt it's tax exempt for your federal taxes. (Though I can't say it's not possible.)
I question also, exactly what the payment is for. You say it's rent (based on what you were told). That may not be correct. It sounds to me like it's probably a one time easement payment. An easement payment is what is usually paid for a "right of way" across property that you own. With such a payment, it's generally not taxable even on the federal return. What it does is reduce your cost basis in the property. That means for example, if you paid $100,000 for the property when you originally purchased it, when you sell the property your cost basis will be reduced by the amount of the easement payment you received.
So if the payment was say, $10,000 and you sell the property later for $150,000, your cost basis is reduced to $90,000 meaning you have a $60,000 taxable gain on the sale.
So if this is "in fact" an easement payment, you don't have to report it on your taxes at all.
However, if that payment is to purchase that land from you, then you have a sale to report on your tax return. Typically (though not always) a 1099-S is issued when property is actually sold. So you may need to call the authority that paid you, to get clarification and confirmation on this. I'm guessing that it's either the county or city that paid you. So you should be able to communicate with the property tax appraiser's office to get clarification and confirmation on just exactly what this transaction was. Easement rights with no change of ownership? Or an actual sale of that portion of the land to the entity that paid you?
Either way reduces your cost basis. But only the sale would have to be reported. (Usually).
There's other possibilities here. But I'd have to write a novel to cover them all. I'm just addressing the most likely ones at this point.
