Cross References
- Reg. §1.471-2(c)

This article is another in a series of articles designed to help answer tax questions that have either been recently posted to our message board or submitted as a content question concerning our publications. In each article, we highlight a particular question that is a current relevant topic, and provide our own research and opinion that may be helpful for the tax preparer community.

Question
This question has to do with outdated inventory. A client had $14,000 in old, unusable inventory, and wants to write it off as cost of goods sold (COGS) in the current year. There were no sales in the current year and the client will probably close the business in the following year. So the question deals with how and when to write off old outdated inventory.

Discussion
The COGS deduction is somewhat unique and different than other deductions in that it is based upon no longer having the value of something, rather than purchasing something. Cost of goods sold implies the deduction is based upon the cost of things that are sold, which is true in many cases. But the deduction also applies to inventory that is stolen, broken, or thrown away. Another confusing concept is that product the taxpayer still has could decrease in value that could cause a lower ending inventory (depending on valuation method in use by the taxpayer) that in turn increases the COGS deduction.

The basic calculation is the value of inventory at the beginning of the year, plus the cost of purchases during the year, minus the value of inventory at the end of the year, equals COGS. While this appears to calculate the cost of product that is sold, it also takes into account all the mysterious disappearances of inventory throughout the year. It also depends on how inventory is valued at the beginning and end of the year. In order to value the beginning and ending inventory amounts, someone has to actually physically count and add up inventory that is on hand at the beginning and end of each year, and then place some type of value on it. The counting part is rather straight forward. If you start with 10 widgets, purchase 3 more, and have 8 left in the end, then your COGS deduction equals the value of 5 widgets (10 + 3 – 8 = 5). It doesn’t matter whether those 5 widgets were sold, broken, lost, stolen, or tossed into the garbage. For tax purposes, the deduction is based on the value of 5 widgets. So before answering the question of how to write-off old outdated inventory, we need to review the basic methods that are allowed for valuing inventory.

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