What this line means
The accounting method you use to value your inventory. The three options are cost, lower of cost or market, and other. Most small businesses use cost — you value inventory at what you paid for it. Lower of cost or market lets you write down inventory that has lost value. The “other” method requires an attachment explaining your approach and is rarely used by sole proprietors.
Does this apply to you?
- You sell physical products and carry inventory
- You manufacture goods and need to track the value of raw materials and finished products
- You buy items for resale and have unsold stock at year-end
- You previously selected a valuation method and must continue using it consistently
Easy to overlook
You cannot switch methods without IRS permission Once you choose a method to value your inventory, you must use it consistently from year to year. Changing methods — for example, switching from cost to lower of cost or market — requires filing Form 3115 (Application for Change in Accounting Method). Switching without permission can trigger an audit adjustment. 1 IRS Publication 334 — Tax Guide for Small Business
Lower of cost or market can create a deduction for obsolete inventory If you have inventory that has declined in value — outdated electronics, expired products, last season’s fashion items — the lower of cost or market method lets you write the inventory down to its current market value. This creates an immediate deduction for the loss in value without physically disposing of the inventory. 2 IRS Schedule C instructions — Part III, Line 33
Watch out for this
Checking a box without understanding the implications. Most sole proprietors should use “cost” unless they have a specific reason to use another method. Selecting “lower of cost or market” and then not actually writing down any inventory to market value gains nothing and adds complexity.
Footnotes
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IRS Publication 334, Tax Guide for Small Business. https://www.irs.gov/pub/irs-pdf/p334.pdf ↩
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IRS Schedule C (Form 1040) Instructions, Part III, Line 33. https://www.irs.gov/instructions/i1040sc ↩