Tax Deductions

Material Purchases as Tax Deductions: COGS, Inventory & the $2,500 Rule

Materials are the most straightforward and often the largest tax deduction for makers. Clay, fabric, wood, metal, packaging, tools—everything you buy to create products qualifies as Cost of Goods Sold (COGS). But there's nuance: the $2,500 threshold between immediate deduction and depreciation, inventory accounting rules, waste documentation, and audit-proof record-keeping. This guide covers it all.

By Nick Jain•January 22, 2025•10 min read

The $2,400 Deduction She Didn't Know About

Sophia runs a candle business. She buys wax, wicks, fragrance oils, jars, and labels regularly. In 2024, she spent $18,000 on materials. When filing taxes, her accountant asked: "Do you have an ending inventory count?"

"What's that?" Sophia replied. She'd been deducting all $18,000 in purchases as expenses. Her accountant explained that's not how material deductions work. You must account for inventory:

COGS = Beginning Inventory + Purchases - Ending Inventory

Sophia's ending inventory (unused materials sitting on shelves): $6,000. Correct COGS deduction: $18,000 - $6,000 = $12,000, not $18,000. She'd been over-deducting by $6,000 for three years.

But here's what she also missed: She threw away $1,200 worth of materials due to defects, expired fragrances, and broken jars. She never documented it, so she couldn't deduct the waste. Real deduction she should have claimed: $13,200 (COGS) + $1,200 (waste) = $14,400. She left $2,400 on the table by not tracking properly.

What Counts as Material Deductions?

Material deductions fall into two categories: Cost of Goods Sold (COGS) and Supplies. Understanding the difference is critical for accurate filing.

COGS: Becomes Part of Product

Materials that physically become part of the finished product you sell.

Examples:

• Ceramicist: Clay, glazes, kiln shelves
• Jewelry maker: Metals, gemstones, findings, chains
• Woodworker: Lumber, stain, varnish, hardware
• Soap maker: Oils, lye, fragrance, colorants
• Textile artist: Fabric, thread, zippers, buttons
• Candle maker: Wax, wicks, fragrance, jars, labels

Supplies: Used But Not Part of Product

Items used in production but don't end up in the final product.

Examples:

• Sandpaper, brushes, mixing tools
• Molds, stamps, cutting tools (under $2,500)
• Cleaning supplies for workspace
• Packaging tape, bubble wrap, shipping boxes
• Safety equipment (gloves, masks, goggles)
• Office supplies (pens, labels, tags)

Tax treatment: Both COGS and supplies are deductible, but they're reported differently. COGS goes on Schedule C Part III. Supplies go in Part II as "Supplies (not included in COGS)."

The $2,500 Threshold: Immediate Deduction vs Depreciation

Here's a critical rule most makers don't know: items costing $2,500 or less can be deducted immediately as materials or supplies. Items over $2,500 must be capitalized as equipment and depreciated over 3-7 years.

How the $2,500 Rule Works

Under $2,500: Deduct Immediately

• $400 sewing machine → deduct $400 this year as "Supplies"
• $1,200 kiln repair → deduct $1,200 this year
• $2,000 pottery wheel → deduct $2,000 this year
• $350 laser cutter lens replacement → deduct $350 this year

Over $2,500: Capitalize and Depreciate

• $6,000 industrial sewing machine → depreciate over 7 years (~$857/year)
• $8,000 kiln → depreciate over 7 years (~$1,143/year)
• $12,000 laser engraver → depreciate over 5 years (~$2,400/year)
• $5,500 CNC router → depreciate over 5 years (~$1,100/year)

Why the $2,500 Threshold Matters

Immediate deduction = full tax benefit this year. Depreciation = tax benefit spread over 3-7 years.

Example impact: Buy $2,400 equipment → save $840 in taxes this year (at 35% rate). Buy $3,000 equipment → save only $150 in taxes this year (first year depreciation ~$430 × 35%).

Strategy: If you need equipment near the $2,500 threshold, consider buying a refurbished or used version under $2,500 for the immediate deduction.

COGS Calculation: The Inventory Formula

You can't deduct all material purchases in the year you buy them. You must account for inventory—materials you bought but haven't used yet. The IRS requires this formula:

COGS Formula

COGS = Beginning Inventory + Purchases - Ending Inventory

Beginning Inventory

The value of unused materials on January 1 (= last year's ending inventory)

Purchases

Total spent on materials during the year

Ending Inventory

The value of unused materials on December 31 (you must count this)

Real Example: Soap Maker's COGS

Beginning inventory (Jan 1, 2024)$3,200

Purchases during 2024$22,000

Ending inventory (Dec 31, 2024)-$4,800

COGS (deductible amount)$20,400

Translation: She bought $22,000 in materials but only gets to deduct $20,400 because $4,800 is still sitting unused on shelves. That $4,800 becomes next year's beginning inventory.

How to Value Ending Inventory

On December 31, you must physically count and value your unused materials. The IRS allows three valuation methods. Most makers use "cost" (what you paid):

Method 1: Cost (Recommended for Most Makers)

Value inventory at what you paid for it. Simple, straightforward, audit-friendly.

Example:

You have 50 lbs of clay remaining. You paid $2/lb. Ending inventory = 50 × $2 = $100.

Method 2: Lower of Cost or Market (LCM)

Value inventory at the lower of what you paid or current market price. Used when material prices drop.

Example:

You paid $5/yd for fabric. Market price now $3/yd. 100 yards on hand. Ending inventory = 100 × $3 = $300 (not $500).

Method 3: FIFO (First In, First Out)

Assume you use oldest materials first. Ending inventory valued at most recent purchase prices.

Most complex. Only use if required by industry or if material prices fluctuate significantly.

Waste, Shrinkage, and Defects: Don't Leave Money Behind

Materials you throw away due to defects, expiration, breakage, or production errors are deductible separately from COGS. But you must document them.

Common Waste Categories for Makers

Production Waste

• Clay cracked in kiln
• Fabric cut wrong and unusable
• Wood split during cutting
• Candles poured incorrectly and discarded
• Soap batch failed and dumped

Expiration/Degradation

• Fragrance oils expired (6-12 month shelf life)
• Paint dried out and unusable
• Fabric faded from sun exposure
• Adhesives hardened past use date
• Food-safe materials past expiration

How to Document Waste

Step 1: Keep a Waste Log

Record date, item, quantity, cost, and reason for disposal. Simple spreadsheet works.

Step 2: Take Photos (Optional but Helpful)

Photo of cracked ceramics, ruined batch, expired materials. Proves disposal was legitimate.

Step 3: Calculate Total Annual Waste

At year-end, sum all waste. Example: $1,200 in defects/waste → deduct as "Materials shrinkage and waste" on Schedule C.

Real Impact: Waste Documentation Saves $450/Year

Ceramicist David started tracking waste in 2024. He discovered:

• 8 pieces cracked in kiln (material cost: $240)
• 3 batches of glaze failed and discarded ($180)
• 50 lbs of clay dried out and unusable ($100)
• Broken/chipped pieces during finishing ($350)
• Tools broken during production ($180)

Total documented waste: $1,050. At 35% tax rate, saved $368 by deducting waste separately.

"I used to just throw things away without thinking. Now I document it. Takes 30 seconds per incident and adds up to real savings."

Bulk Purchases: When to Deduct

What if you buy 6 months of materials at once to get a bulk discount? You deduct in the year purchased, not the year used—but it's counted as inventory until used.

Bulk Purchase Example

Scenario: In December 2024, you buy $8,000 worth of materials to lock in a 20% discount. You won't use them until January-June 2025.

Purchases in 2024$8,000

Used in 2024$0

Ending inventory Dec 31, 2024$8,000

COGS deduction in 2024$0

COGS deduction in 2025 (when used)$8,000

Bottom line: You deduct materials when you use them (via COGS formula), not when you buy them.

Audit-Proof Documentation: What to Keep

If the IRS audits you, they'll ask for proof of material purchases and inventory counts. Here's what to maintain:

1. Purchase Receipts

Keep every receipt: email confirmations from suppliers, credit card statements, invoices, packing slips. Store digitally (scan or photo) and organize by month/category.

2. Inventory Count Records

Document your December 31 inventory count. Spreadsheet with: Item | Quantity | Unit Cost | Total Value. Take photos of materials on shelves as supporting evidence.

3. Waste/Shrinkage Log

Spreadsheet tracking all discarded materials: Date | Item | Qty | Cost | Reason. Photos of defective/broken materials strengthen documentation.

4. Material Usage Records

If you sell custom or varied products, track which materials went into which products. Bill of Materials for each product type proves COGS calculation accuracy.

Common Mistakes That Trigger Audits

Mistake 1: Deducting All Purchases Without Inventory Adjustment

Red flag: $25,000 in purchases but no ending inventory reported. IRS knows you didn't use everything.

Mistake 2: Zero Ending Inventory Year After Year

Claiming you used 100% of materials every year is unrealistic. Always have some inventory remaining.

Mistake 3: No Receipts for Large Purchases

Can't document $8,000 bulk material order? IRS will disallow the deduction.

Mistake 4: Mixing Personal and Business Purchases

Buying fabric for personal sewing projects AND business? Separate transactions or prorate accurately.

Mistake 5: No Waste Documentation

Claiming $2,000 in waste/shrinkage with no log, photos, or explanation? IRS will question it.

How TrueCraft Automates Material Deductions

Manually tracking purchases, calculating COGS, counting inventory, and documenting waste is time-consuming. TrueCraft automates the entire workflow.

Material Cost Tracker

Log every material purchase with photos of receipts. TrueCraft auto-categorizes by material type (raw materials, packaging, tools) and flags items over $2,500 for depreciation.

COGS Calculator

Input beginning inventory, track purchases throughout the year, and enter ending inventory on Dec 31. TrueCraft calculates COGS automatically and populates Schedule C.

Inventory Valuation Tool

Track material quantities and costs. At year-end, enter current on-hand amounts. TrueCraft calculates ending inventory value using your chosen method (cost, LCM, FIFO).

Waste Tracker

Log defects, breakage, expiration with photos. TrueCraft totals waste for the year and adds it as a separate deduction line item. Export documentation for audits.

Receipt Storage

Upload receipts via mobile app. TrueCraft stores them forever, organized by date and category. Export all receipts for a tax year in 2 clicks.

Maximize Material Deductions, Minimize Headaches

TrueCraft automates COGS calculation, inventory tracking, waste documentation, and receipt storage. You focus on making great products. We make sure you keep every dollar you're entitled to.

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