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A poster says that increases in inventory are taxable as income, but I've never heard of such a thing. From what I understand, inventory is simply an exchange of one current asset (cash) for another (goods.

It's quite possible I'm wrong though, but I thought I'd go to the experts. What do you think?
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A poster says that increases in inventory are taxable as income, but I've never heard of such a thing. From what I understand, inventory is simply an exchange of one current asset (cash) for another (goods.

I don't read it the way you did. What I read it as is the expenses that can be deducted are only the expenses of the goods that have actually been sold. Thus, the costs associated with goods in inventory (i.e. not yet sold) is not yet deductible. So, it's not so much that the increase in inventory is taxable income, it's that the income that was spent to increase the inventory doesn't have a taxable deduction yet, so it's all still taxable.

I think the example that the other poster gives illustrates this quite clearly:

To make it simple.

He purchased $100.00 of inventory.

Let's say he had a 50% margin, selling price if he sold it all would be $200.00.

Total sales were $150.00 worth.

150 is gross income
75 is cost of goods sold

75 is net income.

He can't deduct the full $100.00 that he paid for the inventory.

What he wanted to do

150.00 gross income
100.00 inventory purchases

50.00 Net income.

But since he only sold 3/4 of his inventory he couldn't deduct the cost of the remainder.


AJ
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AJ, I guess I'm now going to reveal why I did so poorly in accounting... your explanation was way over my head.

What the example boiled down to (in my apparently muddled thinking) is that the poster was saying the equivalent of "unsold inventory = taxable income".

If that were true, then each home buyer would record the sales price of the home as income the year of its purchase. After all, you know you're going to sell the home later, right? So if you haven't sold it, it's "unsold inventory".

What am I missing?
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What the example boiled down to (in my apparently muddled thinking) is that the poster was saying the equivalent of "unsold inventory = taxable income".


I should have said gross income, using net income was poor terminology on my part. I assumed, incorrectly that there were no other expenses.

Well, it is a bit more complicated than that. The left over inventory is really gross profit (some call it Profit from Sales and some call it Gross Margin)

From that we subtract all the other expenses. Utilities, Rent, insurance, etc.

Total Sales 200.00

Beginning inventory 0.00
Purchases 100.00

Ending inventory 25.00
__________
Cost of goods sold 75.00

Gross profit from Sales 125.00

Utilities 10.00
Rent 10.00
Insurance 10.00

Total Expenses 30.00

Net income 95.00



Does that help?

I still wish I could say it better.


If that were true, then each home buyer would record the sales price of the home as income the year of its purchase. After all, you know you're going to sell the home later, right? So if you haven't sold it, it's "unsold inventory".

You really can't make a comparison to a house. That said, in prior years the gain on the sale of a home was a capital gain. So people did keep track of what they purchased the house for, added the improvements they made. When they sold the Sale price minus the cost and improvement cost was capital gain income.

Technically. for example, if you sell your car at more than you paid for it you should report the difference as a capital gain.

FWIW, I'm glad you came here to verify what I said. I wish more posters did that.

Jean
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Maybe if we go on to year two of my furnace repair guy. He sold the same amount of goods and he replaced those goods he sold. This year he has no increase in inventory. So all the purchases he made can be deducted.



Total Sales 200.00

Beginning inventory 25.00
Purchases 100.00

Ending inventory 25.00
__________
Cost of goods sold 100.00

Gross profit from Sales 125.00

Utilities 10.00
Rent 10.00
Insurance 10.00

Total Expenses 30.00

Net income 95.00



Cool, I've never gotten the < pre > thingy to work before had to try it again!

Jean
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For any nitpickers out there I realize my furnace repair guy had revenue other than from the sale of parts, but they were beside the point for this example.

Jean

Probably projecting
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You really can't make a comparison to a house.

I'm not sure why would there be a difference -- both the home and the purchased parts are acquired with the intent of later resale so it would seem one that both (using your approach) would be taxable income if not sold during the year of acquisition.

This is really, really baffling to me.
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Jean: FWIW, I'm glad you came here to verify what I said. I wish more posters did that.

Thank you -- and I hope I didn't offend. I didn't understand your explanation and thought maybe someone here would be able to offer a different perspective. Alas, I remain confused.....

BG
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BlueGrits:

<<<You really can't make a comparison to a house.>>>

"I'm not sure why would there be a difference -- both the home and the purchased parts are acquired with the intent of later resale so it would seem one that both (using your approach) would be taxable income if not sold during the year of acquisition."

The house is acquired for the purpose of occupancy, presumably. The average person is not in the business of selling homes. The plumber is in the business of selling parts.

Regards, JAFO
(subject to correction by any of the resident pros)
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What the example boiled down to (in my apparently muddled thinking) is that the poster was saying the equivalent of "unsold inventory = taxable income".

That explanation would be wrong. So that might be why you're confused.

What they should have been saying is "unsold inventory = a tax deduction that is deferred until the inventory is sold".

Unsold inventory is not taxable income. Unsold inventory is eventually a deductible expense, but its just not deductible until it's sold. Once the inventory is sold, you can claim a deduction for the cost of the inventory.

--Peter
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so it would seem one that both (using your approach) would be taxable income if not sold during the year of acquisition.

I'm repeating myself here, but that is wrong. Unsold inventory is not taxable income.

Unsold inventory is something that is going to be an expense, it's just not a tax deductible expense yet. You have to wait to deduct that expense until the item is sold.

--Peter
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I'm not sure why would there be a difference -- both the home and the purchased parts are acquired with the intent of later resale so it would seem one that both (using your approach) would be taxable income if not sold during the year of acquisition.

====================================

A house is purchased to live in....then sell it.

Inventory is purchased only to resell it.

Houses are be inventory to a person that only purchases and sells houses with out use between the time they are purchased and the time they sell.

jean
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Unsold inventory is not taxable income. Unsold inventory is eventually a deductible expense, but its just not deductible until it's sold. Once the inventory is sold, you can claim a deduction for the cost of the inventory.

Peter,

The dollar value of unsold inventory does not increase income? Am I that far off base?

The original statement was:

http://boards.fool.com/if-corporations-are-people-why-arent-...

I remember the local furnace repair guy being upset because inventory increases were considered income. It was his first year in business. He bought common replacement parts to have on hand for repairs. The part is not an expense until it is sold.

He had very little actual income that first year, since he spent the money increasing his inventory. He had to pay income tax on the money he used to buy the inventory. This is true whether it's a sole proprietorship or a corporation. He ended up having to borrow money to pay the tax bill that year.

Here is a follow up post

http://boards.fool.com/i-suspect-he-misspoke-and-meant-he-ha...

He was upset because I told him inventory was not deductible until sold, so increases in inventory is taxable income.

I know I used the wrong term (net income), but I was trying to make it simple.

jean
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The dollar value of unsold inventory does not increase income? Am I that far off base?

You're not far off on a bottom-line basis. But I don't like the explanation you used, as I think it leads to confusion rather than clarification.

I wouldn't say that unsold inventory increases income. It only increases income if you start from the incorrect position of having claimed your purchases as an expense. You never should have used unsold inventory to decrease income in the first place.

Technically, I'd call ending inventory a deferred expense. It will be an expense in the future, but it's not an expense yet.

--Peter
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