Inventory Rules — What Home-Business Owners Must Know in 2025
If your home business makes or sells products, inventory rules determine when you get a deduction and how much you can deduct each year.
This guide explains what counts as inventory, how small businesses can deduct inventory under simplified rules, and how the IRS treats production, purchase, and storage costs in 2025.
1️⃣ What Counts as Inventory?
Per Chapter 10 of the course, inventory includes any item you buy or produce with the intention of selling it.
This applies to both physical product sellers and makers.
- ✔️ Materials used to create products
- ✔️ Goods purchased for resale
- ✔️ Work-in-process items (partially completed products)
- ✔️ Finished goods awaiting sale
Not inventory: tools, equipment, or items used in your business.
Important: Inventory only includes items for sale — not supplies or assets used in operations.
2️⃣ What Inventory Costs Are Deductible?
IRS rules require that certain costs be included in inventory until the product is sold, including:
- 📦 Cost of raw materials
- 🛒 Wholesale purchase price of resale items
- 🏭 Direct production labor
- 📥 Shipping charges to acquire goods
- 🏬 Packaging and assembly costs
These costs become deductible when they move from inventory into Cost of Goods Sold (COGS).
3️⃣ Inventory Deduction Methods for Small Businesses
Under the TCJA small-business relief rules, many home-business owners may elect simplified inventory methods.
✔️ Option 1 — Treat Inventory as Non-Incidental Materials & Supplies
Businesses with average annual receipts under $30M (adjusted for inflation) may deduct inventory items when they are first used or consumed, not when sold.
✔️ Option 2 — Follow Your Book Accounting
If your bookkeeping treats inventory in a simplified manner, the IRS allows you to follow the same approach on your tax return.
Tip: Most home businesses use cash-basis accounting + simplified inventory rules to accelerate deductions.
4️⃣ How Cost of Goods Sold (COGS) Works
COGS is the primary way product-based businesses receive deductions. COGS includes:
- Beginning inventory
- + Purchases & production costs
- − Ending inventory
COGS reduces taxable income and self-employment tax by lowering your net profit.
💡 Example — COGS Calculation
Beginning inventory: $2,000
Purchases & production: $6,000
Ending inventory: $1,000
COGS = $7,000
If your product sales were $12,000, your gross profit is $5,000.
5️⃣ Real Examples
💡 Example 1 — Handmade Products
You buy $500 of fabric and $300 of hardware to make handbags.
✔️ Costs go into inventory until the bags are sold.
✔️ Once sold, the costs move into COGS and become deductible.
💡 Example 2 — Product Reseller
You purchase $4,000 of wholesale goods.
✔️ They stay in inventory until sold.
✔️ COGS is recognized only when items sell.
💡 Example 3 — Simplified Method
If treated as non-incidental supplies, you may deduct items when first used, even if not yet sold — allowed for small businesses under TCJA rules.
6️⃣ IRS Documentation Requirements
✔️ Keep these records:
• Purchase invoices
• Production logs or materials usage
• Beginning & ending inventory counts
• Shipping & handling receipts
• Bookkeeping method documentation
Clear inventory documentation is essential — IRS examiners often request COGS support documents first.
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TurboTax Self-Employed — For Freelancers & Home-Business Tax Filing
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- ① Is Your Home Business Really a Business?
- ② Do You Have a Profit Motive?
- ③ Can You Deduct Your Startup Costs?
- ④ Operating Expenses You Can Deduct
- ⑤ Section 179 & Bonus Depreciation
- ⑥ Home Office Deduction
- ⑦ The QBI 20% Deduction
- ⑧ Car & Local Travel Expenses
- ⑨ Out-of-Town Travel Rules
- ⑩ Inventory Rules
- ⑪ Employees vs. Contractors
- ⑫ Health Insurance & Medical Deductions
- ⑬ Retirement Plan Deductions
- ⑭ Additional Business Deductions
- ⑮ Crypto in Your Business
- ⑯ Recordkeeping & Accounting
- ⑰ Spouses in Business Together
- ⑱ How to Avoid an IRS Audit
핑백: S-Corp Audit Risks & Red Flags — What the IRS Looks For in 2025