Can we deduct cost of goods purchased in prior years in preparation for creating a new start up company?

[maddog072349]

The answer from Carl helped but still need clarification. My wife is starting a business that deals with making jewelry and other crafts. She purchased beads and other items used to make the final products over the past several years. Can this "raw material" be entered in the COGS section under "Purchases"? Does this include items purchased in prior years before the business was officially formed?

[Carl]

No. Inventory is dealt with in the COGS section (Cost of Goods Sold) You can't deduct the cost of inventory until the tax year you actually sell that inventory. It does not matter in what year you purchased that inventory either.

For the first year of a business or the first year a business deals in inventory, that Beginning of Year Inventory balance absolutely must be zero. This is because the BOY inventory must match the prior year's EOY (End of Year) inventory. Since the business did not exist (or did not report inventory) in 2017, the 2017 EOY balance was zero. Therefore the 2018 BOY balance has to be zero, so it matches. Period.  Here's a few examples for your specific situation.

 - BOY Inventory Balance = What 'YOU" Paid for the inventory in your possession on Jan 1 of the tax year. It flat out does not matter if you purchased that inventory 50 years ago either. However, if this is the first year of business or first year carrying inventory, then the BOY Inventory balance absolutely *must* be zero.

 - Cost of Goods Sold (COGS) - What "YOU" Paid for the inventory that you actually sold in the tax year. It does not matter in what year you paid for that inventory either.

 - EOY Inventory Balance - What "YOU" paid for the inventory in your possession on Dec 31 of the tax year. It does not matter in what year you purchased that inventory either.

Scenario 1:

You have 1000 widgets that you purchased in 2000 at $1 per widget for a total of $1000.  Then you opened a widget business on Feb 1, 2018 to sell your widgets for $5 each.  During the year you sold 500 of those widgets at $5 each, for a total sales income of $2,500. You COGS will look like this:

BOY Inventory - $0
COGS - $500
EOY Inventory $500

Scenario 2:

You have 1000 widgets that you purchased in 2000 at $1 per widget for a total of $1000. You opened a widget business on Feb 1, 2018 to sell your widgets for $5 each. During the year you had to order 1000 more widgets at a cost to you of $2 each. You sold a total of 1500 widgets at $5 each for a total sales income of $7,500. Your COGS will look like this:

BOY Inventory - $0
COGS $2000 (first in, first out. The first 1000 you sold cost you $1 each. The 2nd 500 you sold cost you $2 each)
EOY Inventory - $1000 (this is half the 2nd lot of 1000 widgets you paid $2 each for, and you still have 500 left)

[Wordsmith_Wearables]

Thank you for this explanation, it makes the concept of existing inventory clearer.  

How does this apply to tools used to create the items I am selling?  I bought a cutting machine and heat press in 2022, but my hobby became a business in 2023. Can I claim the expense of those items, or no? 

[Carl]

How does this apply to tools used to create the items I am selling? Can I claim the expenses of these items also?

No, not directly.

Equipment used in the manufacture of the product you sell is a business asset and gets entered in the Business Assets section. They get depreciated over time. How much time depends on the MACRS classification (type) of equipment you have and it's expected life span as defined in MACRS. It's all spelled out in IRS Publication 946 at https://www.irs.gov/pub/irs-pdf/p946.pdf. Since it appears you purchased the equipment years ago (I may be wrong on that assuption) the cost basis of the equipment will be it's FMV at the time it was placed in service in the business, which is generally less than what you paid for it years ago.