Here's what you do:
Make a control sector outside the level, and make the bottom the height of the bottom of the water block, and the top the height of the top of the water block. Attach one of the four water block effects (experiment with them to find out which one you think is best) to one of the linedefs of the control sector, and tag that linedef to the in-level sector you want to have the water block for.
As for making an FOF above water, that's simple. Make an FOF, and give it the same tag as the water block.
If you're still confused, visit the SRB2 Wiki.