Writing Off Obsolete Inventory: Old GPUs, Servers and Parts

Unsold inventory is not taxed and not deducted while it sits on the shelf. A last-generation eight-GPU server, a GPU baseboard or a superseded cold plate keeps its full cost until the business sells, scraps or gives it away. Before then, the cost can drop at year-end only under two rules in 26 CFR 1.471-2(c): lower of cost or market, or a writedown of subnormal goods actually offered at a reduced price within 30 days after the count. An obsolescence reserve on the books does not reduce taxable income.

Is unsold inventory taxable, and can we write it off?

Unsold inventory creates no income and no deduction until it is sold, scrapped or given away. Cost of goods sold is opening inventory plus purchases and costs, minus closing inventory (Form 1125-A, lines 1 to 8), so goods on hand at year-end carry their cost into a later year.

Only goods the business holds title to count (26 CFR 1.471-1(a)). Two edges follow:

• Goods on order whose title has not passed are not inventory, so there is nothing to write down. A book loss accrued on open GPU purchase orders is not an inventory writedown; ask before deducting it.
• Goods out on consignment with a broker stay in the owner's inventory and can be valued under the same rules.

The routes, and when each lowers taxable income:

Inventory write-down vs write-off: what is the difference for taxes?

A write-down lowers the value of goods the business still holds, using lower of cost or market or the subnormal goods rule. A write-off removes goods the business sold or scrapped. Both reach the return the same way: through a lower closing inventory on Form 1125-A, not as a separate expense line. Gifts work differently; see the donation section below.

Can we write last-generation stock down to lower of cost or market?

A business can value each item at the lower of its cost or its "market" only if lower of cost or market is its inventory method. Under 26 CFR 1.471-4, market means replacement cost: the current bid price on the inventory date, in the volume the business usually buys. It is not the price the business hopes to sell at.

The rules that trip people up:

• Usual volume. A business that buys servers a few at a time uses its own small-lot price, not a large buyer's discount (Publication 538 gives this example).
• No open market. For a discontinued configuration with no quotes, use the best evidence near the count date: actual purchases or sales by the business or others in reasonable volume and in good faith (26 CFR 1.471-4(b)).
• Lower offering price. A business on lower of cost or market that offers goods below replacement cost in its regular course of business can value them at that price less direct selling costs. Its actual sales for a reasonable period before and after the count must back the price (26 CFR 1.471-4(b)).
• Item by item. Compare cost and market for each article, never the whole inventory in total (26 CFR 1.471-4(c)).
• Fixed-price orders. Goods held for a firm, non-cancellable sale at a fixed price stay at cost (26 CFR 1.471-4(a)(2)).
• LIFO. Goods under last-in, first-out are taken "at cost regardless of market value" (26 CFR 1.472-2(b)).
• Vendor credits first. A price-protection credit tied to goods still on hand lowers their cost, because cost is invoice price less trade or other discounts (26 CFR 1.471-3(b)). Do not write the same drop down twice.
• It is a method. The valuation basis is set on the return and used every year. Switching from cost to lower of cost or market needs IRS consent (26 CFR 1.471-2(d)). A FIFO (first-in, first-out) business can usually request it as an automatic change (Rev. Proc. 2025-23, section 22.10), by attaching Form 3115 to its timely filed return, extensions included, for the year of change (Instructions for Form 3115).

When can obsolete or damaged goods go below replacement cost (the 30-day rule)?

Goods that cannot be sold at normal prices, or used in the normal way, can be valued at the price they are actually offered at (the bona fide selling price), less the direct cost of disposal (26 CFR 1.471-2(c)). The regulation lists damage, imperfections, shop wear, changes of style, odd or broken lots and similar causes, including second-hand goods taken in trade. It works under either the cost method or lower of cost or market, and Form 1125-A repeats it.

The 30-day rule decides most cases. A bona fide selling price means an actual offering of the goods during a period ending no later than 30 days after the inventory date. For a December 31 count, the reduced price must be offered by January 30. Raw materials or partly finished goods held for use get a reasonable value based on their condition and usability, never below scrap value.

The burden of proof is on the business. Whether a working but superseded product counts as subnormal depends on the facts; a new generation shipping does not by itself make every older unit subnormal.

The Supreme Court settled the main trap in Thor Power Tool Co. v. Commissioner. A manufacturer wrote excess spare parts down to near scrap value but kept offering them at original prices. The Court disallowed it: there was no objective evidence of lower value, such as actual offerings, sales or contract cancellations. Unless the business uses lower of cost or market and can prove a lower replacement cost, goods it keeps offering at full price keep their cost.

Is an excess and obsolete inventory reserve tax deductible?

No. The regulations reject "deducting from the inventory a reserve for price changes, or an estimated depreciation in the value thereof" (26 CFR 1.471-2(f)(1)). An excess and obsolete reserve booked for financial statements is added back in the return's book-to-tax reconciliation: Schedule M-1, or Schedule M-3 for larger filers (a corporation with total assets of $10,000,000 or more) (Instructions for Form 1120; Instructions for Form 1065). The deduction arrives later, when the goods are offered at a reduced price, scrapped or sold. Reserve policy for the financial statements is a question for the auditor.

How do we write off scrapped or destroyed inventory?

When goods are destroyed or sent to an e-waste recycler, they leave closing inventory, so their cost lands in cost of goods sold for that year. Anything the recycler or IT asset disposition (ITAD) vendor pays is income; Publication 334 lists income from scrap sales as business income. Inventory lost to a casualty or theft goes through cost of goods sold, or can be claimed separately as a casualty loss with inventory adjusted so it is not counted twice; insurance received is taxable (Publication 538).

What proof does the IRS want?

The IRS wants dated evidence of what each item cost and what it was really worth or offered at on the count date; the burden is on the business (26 CFR 1.471-2(c) and (e)). For subnormal goods, it must also keep records of how the goods were disposed of. In practice:

Can we donate obsolete inventory instead, and what is the deduction?

A business can give inventory to a qualified charity, but for stock worth less than cost the gift usually deducts less than selling or scrapping. Under 26 U.S.C. 170(e)(1)(A), a gift of inventory counts at the lower of its value and its cost. Value is the price the business would get in its usual market, in the quantity given; if it could no longer expect its usual price, value is what that quantity would actually have sold for at the time (26 CFR 1.170A-1(c)(2) and (3)).

The cost is handled separately (26 CFR 1.170A-1(c)(4)):

• Cost carried in opening inventory comes out of inventory and is not cost of goods sold.
• Cost bought or built in the gift year stays in cost of goods sold, and the gift itself then counts at zero.

So selling or scrapping runs the full cost through cost of goods sold, while a gift deducts only the value. No source settles whether the gap is deductible some other way, so ask before assuming it is.

Corporations. For tax years beginning after December 31, 2025, a corporation's gifts count only above 1% and up to 10% of taxable income (Public Law 119-21, section 70426). The excess over the cap carries forward 5 years. The part under the floor carries forward only from a year in which the cap was exceeded. In a loss year there is no current deduction, and any carryforward has limits.

Partnerships and S corporations. The entity reports noncash gifts on Schedule K (line 13b for a partnership, line 12b for an S corporation) and passes them to each owner's Schedule K-1 (box 13 or box 12, codes C or D). Each owner deducts under their own limits (Instructions for Form 1065; Instructions for Form 1120-S).

Enhanced deductions. Two narrow rules for C corporations, for goods used solely for the care of the ill, the needy or infants (26 U.S.C. 170(e)(3)) and for new scientific equipment the corporation built itself and gives for research (26 U.S.C. 170(e)(4)), add nothing for goods worth less than cost. A server assembled mostly from bought-in GPUs and boards will often fail the second rule's parts-cost test. Ask before counting on either.

Paperwork. Keep the charity's written acknowledgment for a gift of $250 or more (26 U.S.C. 170(f)(8)), and attach Form 8283 above its thresholds (Instructions for Form 8283); inventory needs no qualified appraisal.

Does the small business inventory method change any of this?

It can. A business with average gross receipts of $32,000,000 or less over the three prior years, that is not a tax shelter, may use a simpler inventory method (26 CFR 1.471-1(b); figure from IRB 2025-45):

Ask before counting on a book writedown under either method. Losing the method above the limit, Form 3115 and the section 481(a) adjustment are covered in switching from cash to accrual accounting.

How do we record the write-off in the books and on the return?

In the books, a write-off debits cost of goods sold (or an obsolescence expense) and credits inventory. An estimate credits an inventory reserve instead, which the return adds back. Any accounting ledger records either entry the same way.

On Form 1125-A:

• Enter the lower closing value on line 7, which raises cost of goods sold on line 8.
• Check line 9a(ii) for lower of cost or market.
• Check line 9b for a writedown of subnormal goods.
• Answer Yes on line 9f, with an explanation, if quantities, cost or valuations changed between opening and closing inventory.

A large writedown can create a loss. A C corporation carries it forward against up to 80% of later taxable income; see how C corporations are taxed. Partners' basis, at-risk and passive limits are in business losses.

We used the wrong method in past years: how do we fix it?

A business that deducted a reserve, or valued subnormal goods outside the 30-day rule, is using an impermissible method. It usually corrects this going forward with an automatic method change (Rev. Proc. 2025-23, section 22.04), not by amending old returns. The filing and the catch-up adjustment are explained in switching from cash to accrual accounting. If the inventory counts themselves are missing, start with catching up on overdue books.

How does Canada (CRA) treat an inventory write-down?

Canada also allows a write-down to the lower of cost and fair market value at year-end, but with no 30-day offering test (Income Tax Act, section 10).

A Canadian corporation's year-end statements and T2 are covered in year-end financial statements for a corporation.

Example

All figures are illustrative, in US dollars.

A GPU server reseller with last-generation stock

A Delaware C corporation resells GPU servers from California. Its average gross receipts are $80,000,000, so the small business method is not available, and it uses FIFO. At its December 31 count it holds 20 last-generation eight-GPU servers bought earlier that year at $300,000 each ($6,000,000), after the next generation shipped.

• Still asking $320,000, on the cost method: no writedown. The controller's $3,000,000 obsolescence reserve is added back on Schedule M-1 or M-3.
• On lower of cost or market: distributor quotes and its own January purchases of the same configuration show $220,000 in its usual volume. Closing inventory drops by $1,600,000 (20 × $80,000). Units committed to a customer at a fixed price stay at cost.
• Offered at a reduced price: on January 15 it offers the units to its customer and broker list at $190,000, with $5,000 a unit of freight and commission. If they qualify as subnormal, each is valued at $185,000, a $2,300,000 writedown for the year, and line 9b is checked. Sold in March at $190,000, each unit breaks even next year after the $5,000 of selling costs already netted in its value.

A cooling maker scrapping first-revision cold plates

A Texas LLC taxed as a partnership with two partners revises its cold plate design. It holds 2,000 first-revision cold plates that cost $500 each ($1,000,000).

• It keeps 200 as service spares sold at normal prices. They stay at cost: $100,000.
• It scraps 1,800 in December through a metal recycler that pays $20 each. $900,000 goes through cost of goods sold, the $36,000 is income, and partnership income drops by $864,000, split on the partners' K-1s.
• It keeps the dated change order, count sheets, weight ticket and certificate of destruction.
• For Texas franchise tax, cost of goods sold can include costs tied to obsolescence (Texas Comptroller); see Texas franchise tax deductions.

A server integrator giving servers to a university lab

A Virginia C corporation has $2,000,000 of taxable income before the gift, with the servers' cost already out of cost of goods sold. It gives 10 last-generation servers to a university research lab. They were bought the prior year for $40,000 each ($400,000) and would sell for $100,000 in total in its usual market.

• The gift counts at $100,000. The $400,000 comes out of opening inventory and is not cost of goods sold.
• The corporate limits allow only the part above 1% of taxable income ($20,000) and up to 10% ($200,000): $80,000 is deducted. The $20,000 under the floor is lost, because the 10% cap was not reached.
• Under these facts, selling the servers for $100,000 would put $300,000 of net cost through cost of goods sold, and scrapping them $400,000, with no 1% floor or 10% cap.

Different for you?

• Servers you used or rented out, and selling, trading in or scrapping them: writing off GPU servers.
• Tariffs, duties and freight in inventory cost: tariffs and duties on imported equipment.
• A prototype or pilot build that may be research rather than inventory: deducting hardware research and prototypes.
• Units left after a customer cancels, or a forfeited deposit: customer prepayments and deposits.
• Changing your inventory method, or a past reserve to unwind: switching from cash to accrual accounting.
• Texas franchise tax on the same stock: Texas franchise tax deductions.
• A large writedown, a donation or a method change for a reseller, integrator or cooling maker: data center tax services.

Out of scope here: audits or reviews of financial statements, customs valuation and duty refunds, export licences for selling used equipment abroad, county property tax on inventory, and drafting vendor return terms.