What you pay for inventory is not deductible until the tax year you sell that inventory. Doesn't matter if that inventory was purchased years ago either. Here's an example of how this works, and my example covers two years - the first year and 2nd year of dealing with inventory.
IN the first year of business or first year dealing with inventory, the BOY (Beginning of Year) inventory balance must be zero. There are no exceptions. This is because your BOY inventory balance must match exactly your prior year's EOY (End of Year) inventory balance. So if 2021 was your first year dealing with inventory, the only way possible for the 2021 BOY inventory balance to match exactly your 2020 EOY inventory balance, is for the 2021 BOY inventory balance to be zero. Again, there are no exceptions.
Year 1:
BOY Inventory balance - $0 (This is what *YOU* paid for the inventory in your physical possession on Jan 1 of the tax year)
Cost of Goods Sold (COGS) - $1000 (What *YOU* paid for the inventory you actually sold during the tax year)
EOY Inventory balance - $2000 (What "YOU" Paid for the inventory in your physical possession on Dec 31 of the tax year)
The above shows you started the year with no inventory, and throughout the year you purchased/acquired $3000 of inventory. During that same year you sold $1000 of that inventory leaving you with a EOY inventory balance of $2000 on Dec 31 of the tax year. The amount shown in COGS is deductible from your gross business income for that tax year.
Year 2:
BOY Inventory balance - $2000 (Matches "exactly" your prior year EOY Inventory balance)
COGS - $4000 (what "YOU" paid for the inventory you actually sold during the tax year. Doesn't matter when it was purchased either.)
EOY Inventory balance - $3000 (what "you" paid for the inventory in your physical possession on Dec 31 of the tax year. Again, it doesn't matter when that inventory was purchased either.
The above shows you started the tax year with $2000 of inventory. it also matches exactly the prior year's EOY inventory. If it does not match, then you have some explaining to do to the IRS. Head's up on that - if your BOY inventory balance does not match your EOY inventory balance of the prior year, there is "NO" explanation possible that the IRS will accept.
During the year, you purchased an additional $5000 of inventory to bring your total inventory for the tax year to $7000. (the $2000 you started with, plus the $5000 you purchased.) Then you sold $4000 of that inventory during the tax year, leaving you with an EOY inventory balance of $3000.
The amount you sold as indicated in COGS, is what will be deducted from your gross business income for the tax year.
While the above may seem complicated, it really is simple once you understand it. Most of the time if you just "think it through", it makes perfect sense.
