Who this is for
- US sole proprietors and single-member LLC owners who paid for stock on a personal card or account before opening
- Partners and shareholders who bring stock they bought into a new partnership or corporation
Not covered here
- Whether a small seller should expense stock or hold it as inventory
- Whether reselling is a hobby or a business
- Rebuilding cost when no records exist, and correcting returns already filed
- Freight, duty and sales tax on stock, state income tax and resale certificates
- Stock received as a gift or inheritance
How do I record seed inventory I bought personally before opening?
Generally, record the stock (your opening inventory) in the business's books at what you paid: debit Inventory (an asset) and credit Owner contribution (equity). No money moves, so the business bank account shows nothing. The entry is not income and not an expense. The cost leaves Inventory and becomes cost of goods sold (the cost of the units you sold) as the stock sells (Publication 334; Publication 538).
| Step | Debit | Credit |
|---|---|---|
| The stock comes into the books | Inventory | Owner contribution (each owner's capital account if there is more than one) |
| A unit sells | Cost of goods sold | Inventory |
Date the first entry the day the stock became the business's: the day you took title (ownership) if you bought it for the business and your books cover that day, otherwise the first day of the books (post it as an opening balance). Goods you have paid for but do not yet own are not inventory (26 CFR 1.471-1). For a partnership or corporation it is the day title passed to the entity, never the day an owner paid. If your software puts it in Opening Balance Equity (a holding account for opening entries), move it to Owner contribution (Opening Balance Equity; books that start late).
Keep the stock list item by item, with quantity and unit cost. If your software tracks inventory, enter it that way so each sale takes its cost out of Inventory; one lump-sum entry gives it nothing to take out.
If the business later pays the personal card bill for the stock, do not book a new purchase; the stock is already in Inventory. For a sole proprietor or single-member LLC, book the payment as an owner draw (a loan repayment, if you recorded a loan) (recording owner's draws). For a partnership or corporation, it may be a distribution, a loan repayment or the price of buying the stock; settle which before posting it (see the entity section). Whether the stock is a contribution or a loan depends on the entity and on whether the business is to repay you; see owner contribution or loan.
For a sole proprietor or single-member LLC, the owner and the business are one taxpayer for income tax (IRS), so a personal-card purchase of goods the business sells is the business's cost. No IRS publication or regulation cited on this page addresses stock bought before the first business day. The treatment here follows from the cost-of-goods-sold formula and the cost rule. A partnership or corporation is a separate taxpayer; see the entity section below.
Under the default rule, stock is not expensed when you pay and is not a start-up cost: its cost is deducted through cost of goods sold as it sells (section 195(c)). Some small sellers may use other methods; see inventory or supplies for small sellers. Other start-up costs are in startup costs paid personally.
A case is not simple if:
- the stock mixes new purchases with items you have owned for years, or is a collection or other items you owned long before opening;
- you cannot find receipts or card statements;
- someone other than the owner paid, such as a spouse or relative;
- the stock was bought abroad or in another currency, or came with duty or import costs (see landed cost);
- a partnership or corporation, not you alone, owns the business;
- the opening year's return is already filed;
- the stock was already deducted once, as supplies or purchases, on an earlier return.
Gather receipts, card statements or order emails showing what you bought, who paid, when and for how much; the date you opened; the entity type; and any filed returns.
What counts as starting inventory, and how is it different from supplies?
Starting inventory is goods you hold to resell, plus raw materials that become part of what you sell. Publication 583 calls inventory any item you buy and resell. Publication 538 lists merchandise, raw materials, work in process, finished products and supplies that physically become part of the item for sale. It leaves out equipment and supplies that do not become part of the item.
| What you bought | Inventory? | Why |
|---|---|---|
| Finished goods to resell | Yes | Goods bought for sale |
| Wax, wicks and jars you turn into candles | Yes | Raw materials that become part of the product |
| Shelves, a display case, a label printer | No: equipment | Equipment used in the business (Publication 538) |
| Items bought for you or your family | No | Personal use comes out of purchases (Publication 334) |
Whether a small seller may expense stock instead is in inventory or supplies for small sellers. Packaging and containers are in landed cost.
Should I record what I paid or what the stock is worth now?
Record what you paid. Cost is the invoice price less trade discounts, plus transportation and other necessary charges to get the goods (26 CFR 1.471-3). The same idea is in Publication 551: the basis of property you buy (its cost for tax purposes, adjusted for later changes) is usually what you paid, including sales tax and freight. The IRS allows inventory at cost or at the lower of cost or market, which values each item at the lower of the two (Schedule C instructions, line 33). Neither method writes stock up above cost. (A partnership's capital accounts are the exception; see the entity section.)
| Situation | Carry the stock at |
|---|---|
| Worth more than you paid | What you paid |
| Stock bought to resell, now worth less than you paid | Cost under the cost method; the lower market value, item by item, under lower of cost or market |
| Stock moved in from personal use | See the collection section below |
Under lower of cost or market, "market" means the usual bid price on the date of inventory for the volume you usually buy (Publication 538), not what you hope to sell the item for.
Pick one method and keep it: inventory practices must be consistent from year to year (Publication 538). Freight, duty and sales tax paid on stock are in landed cost; damaged or dead stock is in writing off dead stock.
What if the stock is a personal collection I owned for years?
For a sole proprietor or single-member LLC, a collection's cost is still the ceiling: value above what you paid is never booked. (A partnership's capital accounts work differently; see the entity section.) The IRS publications cited here do not say how a long-held personal collection is carried once a business starts selling it, so whether to carry cost or a lower value on the day it enters the business is a judgment for a preparer before the first sale.
What the IRS materials do say points to four things to settle:
- Value below cost is open. Publication 551 points toward the lower figure for property moved from personal to business use: the depreciation basis is the lesser of fair market value and adjusted basis on the date of the change, and a later loss starts from that lower figure. It does not mention inventory, so it guides rather than decides.
- A drop in value while the items were personal is not automatically a business loss. An individual's loss deductions are limited to a trade or business, a transaction entered into for profit, and casualty or theft (section 165(c)).
- The character of the sale can change. Property held mainly for sale to customers in a business is not a capital asset (section 1221(a)(1)), so gain from selling the collection through the business may be business income.
- Whether it is a business at all. Occasional sales of a collection may not be one; see hobby or business.
Keep two numbers for each item: the cost, with its receipt, and the value on the day it entered the business, with the evidence (a listing, a price guide or an appraisal). If the old receipts are gone, see cost of goods without records.
Does the entry change for a single-member LLC, a partnership or a corporation?
The entry changes with the entity. The debit is always Inventory; the credit and the tax treatment depend on how the business is taxed. An LLC follows the row for how it is taxed: one member is treated as the same taxpayer as the owner (a disregarded entity), two or more are a partnership (spouses who own it as community property may report it either way), unless it elects corporate treatment (IRS).
| The business is | Credit | Tax treatment of the transfer | Return |
|---|---|---|---|
| Sole proprietorship or single-member LLC | Owner contribution | One taxpayer, so nothing is sold; stock stays at your cost | Schedule C, Part III |
| Partnership or multi-member LLC | Each partner's capital account | Generally no gain or loss to partner or partnership (section 721); the partnership's basis is the partner's adjusted basis (section 723) | Form 1065 with Form 1125-A |
| Corporation, including an LLC taxed as one and an S corporation | Common stock or paid-in capital; a shareholder loan account only if the corporation is to repay it, which can make the transfer a sale | Generally not taxable if the transferors control the corporation right after, or if it is a contribution to capital; the corporation's basis is the shareholder's basis, plus any gain the shareholder recognizes (Publication 542; section 362(a)) | Form 1120 or 1120-S with Form 1125-A |
Six points for partnerships and corporations:
- Capital account versus tax basis. A partnership that follows the capital-account rules credits a partner's capital with the stock's fair market value on the day it is contributed (26 CFR 1.704-1(b)(2)(iv)(d)), while its tax basis stays at the partner's adjusted basis. The gap is tracked and allocated when the stock sells (Publication 541).
- Value below cost. If the stock a corporation takes for shares is worth less in total than its basis, the corporation's basis is capped at that value (section 362(e)(2)). The transferor and the corporation can instead elect to cut the owner's share basis; the election is irrevocable and needs a written agreement first and a statement with the timely filed (extensions included) return for the transfer year (Publication 542; 26 CFR 1.362-4(d)). In a partnership the built-in loss counts only toward the contributing partner (section 704(c)(1)(C)). Raise this with a preparer before the transfer.
- Character of the sale. For five years after the contribution, a partnership's gain or loss on stock that was inventory in the partner's hands is ordinary. Its loss on an item that was a capital asset in the partner's hands, such as a personal collection, is a capital loss, up to the built-in loss (section 724; Publication 541).
- Statements. A transfer of property for shares can require a statement of the property's value and basis with the owner's return and with the corporation's return for that year (26 CFR 1.351-3). Bring the transfer date, cost and value to the preparer.
- Later changes. A second member joining a one-member LLC makes it a partnership. An LLC that elects corporate treatment on Form 8832 is treated as contributing its assets, stock included, to a corporation for shares; the election takes effect on the date it names, up to 75 days before or 12 months after the filing date (26 CFR 301.7701-3). Redo the entity row from that date.
If the entity pays you for the stock instead of crediting your capital, the transfer may be a sale. A partnership that pays a partner money or other consideration within 2 years before or after the contribution is presumed to have bought the property, unless the facts clearly show otherwise (section 707(a)(2)(B); 26 CFR 1.707-3). See owner contribution or loan and LLC equity accounts.
Where does starting inventory go on Schedule C: beginning inventory or purchases?
If you keep an inventory, starting inventory goes on line 35 when you bought it in an earlier tax year than the one the business starts, and on line 36 when you bought it in the business's first tax year, even before the first sale. Publication 334 defines line 35 as the cost of merchandise on hand at the beginning of the year that you will sell, and line 36 as the cost of all merchandise you bought for sale. No IRS publication cited here addresses stock bought before opening, so confirm the placement with a preparer.
| When you took title to the stock | Line | Why |
|---|---|---|
| In a tax year before the business's first year | 35, Inventory at beginning of year | On hand at the start of the first year |
| Any time in the business's first tax year | 36, Purchases | Bought during the year |
| Stock unsold at year end | 41, Inventory at end of year | It becomes next year's line 35 |
Cost of goods sold is lines 35 through 39 added up, less line 41 (Publication 334), so either line puts the same cost into cost of goods sold; the rest of Part III is in cost of goods sold on Schedule C. If part of the stock was bought in each year, split it between the two lines. Opening inventory usually equals last year's closing inventory, and any difference must be explained in a schedule attached to the return (Publication 334). A first-year business has no last-year figure to match; a short note (what the stock is, when you bought it, what it cost) answers the question the line asks.
A partnership or corporation reports the same pieces on Form 1125-A: line 1 is inventory at the beginning of the year and line 2 is purchases. By those labels, stock the entity holds on the first day of its first tax year fits line 1 and stock it receives later fits line 2. The form instructions do not address contributed stock, so confirm the placement with a preparer.
Do I have to count inventory at year end, and can a small business skip it?
Most businesses that buy goods to resell must take inventory at the start and end of each tax year (Schedule C instructions, Part III; 26 CFR 1.471-1). A business that keeps an inventory generally uses an accrual method for purchases and sales, and may use the cash method for everything else (Publication 538). A small business taxpayer may choose not to keep one. That means average annual gross receipts of $32,000,000 or less for the three prior tax years, using the years it has existed if the business is newer, counting related businesses together and, for an individual, all your trades or businesses, and not a tax shelter (section 471(c); section 448(c); 26 CFR 1.471-1(b); Schedule C instructions, Part III).
A small business taxpayer that skips the inventory must still use a method that clearly reflects income (Schedule C instructions). Which method fits, and how to switch, is in inventory or supplies for small sellers.
If the books carry an Inventory balance, check it against a count of the shelf at reasonable intervals (26 CFR 1.471-2(d)).
What proof of cost do I keep?
Keep, for each lot, a document showing the amount paid and that it was for inventory. Publication 583 names canceled checks, register receipts, credit card sales slips and invoices. A card statement shows the amount paid; an invoice, receipt or order email shows the purchase was stock.
- A stock list as of the day the stock entered the business: item, quantity, unit cost, date bought and the document behind each cost. Inventories must be recorded legibly and preserved with the accounting records, and the taxpayer must satisfy the IRS of the correctness of the prices (26 CFR 1.471-2(e)).
- For stock moved into a partnership or corporation, the owner's own purchase records as well as the entity's, because the entity's basis is the owner's basis (section 723; section 362(a)). Publication 583 gives the same keep-both rule for property received in a nontaxable exchange.
Keep records on property until the period of limitations ends for the year you dispose of it. The usual period is 3 years after the return is filed (or its due date, if later), longer in some cases (Publication 583, Table 3).
What if my receipts are gone or I already filed without the stock?
For lost receipts, rebuild the proof from card or bank statements, the seller's order history and email confirmations, and keep a note of how each figure was found; see lost receipts. An estimate still has to be supported, because the taxpayer must satisfy the IRS of the prices used. For years of resale with no records, see cost of goods without records.
For a filed return, check first whether the stock was deducted already, as supplies or purchases. Entering it again as beginning inventory would count it twice. If it was left off entirely, the effect depends on how much of it sold in that year and whether the omission repeated; see fixing inventory missing from past returns.
Example
These examples are illustrative; figures are in US dollars.
Single-member LLC: candles on a personal card
In November an owner pays $4,000 on a personal card for candles to resell and takes delivery the same month. The LLC opens in January and gets a bank account in February. She keeps an inventory at cost.
- Books. On the first day of the books: debit Inventory $4,000, credit Owner contribution $4,000. No bank transaction; not income, not an expense, and nothing deducted for November.
- Opening year. She sells candles that cost $3,000 for $7,500 and buys $2,000 more from the business account. Schedule C shows line 35 $4,000, line 36 $2,000 and line 41 $3,000, so cost of goods sold is $3,000 and gross profit is $4,500.
- Next year. Line 35 starts at $3,000, last year's line 41.
Had she paid the $4,000 in January of the opening year, it would be on line 36 and line 35 would be zero.
A card collection moves into a new shop
A seller bought a card collection years ago for $2,500; it is now worth $6,000. She opens a one-owner shop and puts the cards on the shelves. The books never show $6,000, because cost and lower of cost or market both stop at cost. Whether to carry $2,500 or something lower, and whether the sales are business income or the sale of a personal collection, depends on how she held the cards and how the shop sells them. The IRS materials do not settle it. Settling it before the first sale matters; a preparer would ask for the old receipts and a dated record of the value on the day the cards went in.
Two partners bring in stock
Each of two partners bought $10,000 of stock to resell and transfers it to a new partnership. Assume each lot is also worth $10,000 and carries no debt. The partnership debits Inventory $20,000 and credits Partner A capital $10,000 and Partner B capital $10,000, dated the day the stock transfers. Its tax basis in each partner's lot is that partner's adjusted basis, $10,000, so capital and tax basis agree. Had a lot been worth more than $10,000, its capital account would exceed the basis and the gap would be tracked until the stock sells.
Different for you?
- A return for the opening year is already filed without the stock, or the stock is old personal items, alone or mixed with new purchases: the cost to carry, the opening entries and any fix to a filed return turn on facts a preparer must settle. Get bookkeeping help, and see fixing inventory missing from past returns.
- The owners will be paid back for the stock, or capital accounts will use a value above cost: the transfer may be a sale, and the books and tax basis part ways. Get bookkeeping help before the entity pays anyone.
- You have no receipts: see cost of goods without records and get bookkeeping help to rebuild cost from what exists.
- You are not sure the selling is a business: see hobby or business.
- The business ran before the books started: see opening balances when books start late.
- You moved a car, computer or tools in, not stock: see putting personal assets into your LLC.
- You want to expense stock or track it as supplies: see inventory or supplies for small sellers and cost of goods sold on Schedule C.
- You received the stock as a gift or inheritance: your starting figure is not what you paid. Publication 551 covers basis for gifts and inherited property.
Figures on this page
| Figure | Value | Source |
|---|---|---|
| Window for the effective date of an entity classification election Form 8832 election effective date can be no more than 75 days before and no more than 12 months after the date the election is filed; an earlier date is moved to 75 days before filing | Up to 75 days before or 12 months after | 26 CFR 301.7701-3(c)(1)(iii), classification of certain business entities Checked |
| Period in which a contribution and a payback are presumed a sale A contribution of property and a transfer of money or other consideration to the partner within this period of each other, before or after, is presumed a sale unless the facts clearly show otherwise; a Form 8275 statement is generally required, with exceptions in the regulations | 2 years | IRS: Publication 541, Partnerships Checked |
| Small-business inventory gross-receipts test Average annual gross receipts for the three prior tax years under section 448(c); other conditions apply to the inventory-method exception. | $32,000,000 Tax year 2026 | IRS: Internal Revenue Bulletin 2025-45 Checked |
| General income-tax supporting record retention period Generally after filing or the return due date, whichever is later; longer periods apply in specified cases. Property-basis records last through the limitation period for the taxable disposition year; unfiled and fraudulent returns have no limitation period. | 3 years | IRS: Publication 583, How Long To Keep Records and Table 3 Checked |
Primary sources
- IRS: Publication 334, Tax Guide for Small Business
- IRS: Publication 538, Accounting Periods and Methods
- IRS: Instructions for Schedule C (Form 1040)
- IRS: Publication 583, Starting a Business and Keeping Records
- IRS: Publication 551, Basis of Assets
- IRS: Single member limited liability companies
- IRS: Publication 541, Partnerships
- IRS: Publication 542, Corporations
- IRS: Form 1125-A, Cost of Goods Sold
- US Code: 26 U.S.C. 471, general rule for inventories
- US Code: 26 U.S.C. 195, start-up expenditures
- US Code: 26 U.S.C. 721, nonrecognition on contribution to a partnership
- US Code: 26 U.S.C. 723, basis of property contributed to a partnership
- US Code: 26 U.S.C. 704, partner's distributive share
- US Code: 26 U.S.C. 362, basis to corporations
- US Code: 26 U.S.C. 1221, capital asset defined
- US Code: 26 U.S.C. 165, losses
- 26 CFR 1.471-1, need for inventories
- 26 CFR 1.471-2, valuation of inventories
- 26 CFR 1.471-3, inventories at cost
- US Code: 26 U.S.C. 448, gross receipts test
- US Code: 26 U.S.C. 724, character of gain or loss on contributed property
- US Code: 26 U.S.C. 707, transactions between partner and partnership
- 26 CFR 1.707-3, disguised sales of property to a partnership
- 26 CFR 1.704-1, partner's distributive share
- 26 CFR 1.351-3, records and information for section 351 exchanges
- 26 CFR 1.362-4, basis reduction and election for built-in losses
- 26 CFR 301.7701-3, classification of certain business entities
About this guide
Published by Cloud Accounting under standing professional approval. This version has no separately recorded personal review. It explains general rules for the tax year shown. It is not advice for your situation.
Changes
- : First published.