If you are a business owner with leftover inventory in your warehouse, you can deduct the cost of these items on your tax return. Two things need to happen for this deduction to work. First you need to have qualified items in storage. Inventory that includes merchandise or stock in trade, raw materials for merchandise that you sell, any works in process, finished products that you intend to sell, or supplies that will physically become parts of the items you will eventually sell. The key here is the products or properties you are holding in the warehouse or storage for selling, one way or the other they are intended to go out.
Inventory that is not considered is merchandise that has already been sold to the customer with a title, or goods that are being ordered by you that you dont hold the title for, land, building, or equipment you use in your business, goods that are consigned to your business, supplies that dont physically become part of the goods that you sell, notes or accounts receivable or similar assets, plus real estate that is held by a real estate dealer or to be sold in the ordinary course of his business.
Now that we know what the IRS considers inventory, lets look at ways to determine the cost of the items in inventory. Most businesses use the accrual method of accounting to begin with. This method reports income in the tax year that you earn it , not when the payments are physically received, and deducts the expenses as they are incurred not when the payments are made. Following are some ways to determine the cost of the items in inventory: