If your client is a business owner with leftover inventory in their warehouse, you can deduct the cost of these items on their tax return. Two things need to happen for this deduction to work. First your client needs to have qualified items in storage. Inventory that includes merchandise or stock in trade, raw materials for merchandise that your client sells, any works in process, finished products that your client intends to sell, or supplies that will physically become parts of the items they will eventually sell. The key here is the products or properties your client is 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 your client that they dont hold the title for, land, building, or equipment they use in their business, goods that are consigned to their business, supplies that dont physically become part of the goods that they 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/her 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 your client earns 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: