Water in SRB2 is a type of Floor Over Floor. The ceiling of the control sector is the surface of the water, and the floor is the bottom. If the floor is placed above the floor of the target sector, the water will end up as a literal block of water floating in air. If the Effect 5 flag is checked on the control linedef, it will generate a water ripple on the surface of the water.
The texture used for the control linedef is the texture used on the side of the block. Use a waterfall texture here and the edge of the block will look like falling water. Place another water block next to it at a lower level to create a waterfall. If you're not using the waterfall feature, it's a good idea to use the "No Sides" water types to make it slightly faster to render.
Current linedef types available for water FOFs:
An important point in making water blocks is to use a Colormap. Make a new control sector and select a linedef. Set the control linedef's upper texture to #40A0FFJ. Tag the control linedef to the water's control sector. The colormap is what causes the greenish-blue tint when the player is underwater.
Liquids other than water are made simply by changing the textures and colormap. If the liquid is painful, apply the damage sector effect to the water's control sector.
#FF7F00Z. Unlike other liquids, put #FF7F00Z on both the upper and lower texture of the colormap control linedef and check the Effect 6 flag to create the fog effect inside the lava.
#E000E0S for the colormap, but #FF00FFS is also a good option.
#999999D for the colormap.