The tax treatment of inventory disposal turns on a distinction that catches a lot of businesses off guard: the write-down you record on your books when goods lose value is not, by itself, a tax deduction. The deduction generally waits until you physically sell, donate, or destroy the goods. Get that timing wrong and you either claim a loss too early or fail to document the event that actually triggers one.
Why the Book Write-Down Isn’t the Tax Event
GAAP requires you to carry non-LIFO inventory at the lower of cost or net realizable value, so when merchandise is impaired, you write it down for financial reporting purposes in the period you identify the loss. That entry satisfies your auditors. It does not, on its own, reduce your taxable income.
For tax purposes, inventory losses generally flow through cost of goods sold when the goods are actually sold or disposed of. The book write-down creates a temporary book-tax difference, usually tracked as a deferred tax asset, until a real-world disposition catches the tax return up to the books.
There is one narrow exception. A business that does not use LIFO may take a tax deduction for a write-down if it offers the goods for sale at the reduced price for at least 30 days after the inventory date.1U.S. Small Business Administration. Tax Results for Giving Up on Company Property Outside that scenario, assume the tax benefit arrives with the physical disposal, not with the journal entry.
Selling at a Discount
Liquidation through clearance events, online markdowns, or a third-party liquidator is usually the first option because it recovers cash. The tax treatment is ordinary: sale proceeds are business revenue, and the cost basis of the goods flows through cost of goods sold.
If the write-down did not independently qualify for tax recognition, the full economic loss lands in the year of sale. Inventory that cost $50,000, was written down on the books to $12,000, and then sold to a liquidator for $8,000 produces $8,000 of revenue against $50,000 of tax basis in COGS, capturing the $42,000 loss in the sale year.
Destroying the Inventory
Physical destruction produces an ordinary loss under IRC Section 165, which allows a deduction for losses sustained during the taxable year that are not compensated by insurance.2Office of the Law Revision Counsel. 26 US Code 165 – Losses The deduction equals the remaining tax basis of the destroyed goods and is fully available in the year the destruction occurs, which makes it a clean event for timing purposes.
Tax basis here is broader than purchase price. If your business is subject to the uniform capitalization rules, indirect costs capitalized under Section 263A are part of the basis and become part of the deductible loss.3Office of the Law Revision Counsel. 26 US Code 263A – Capitalization and Inclusion in Inventory Costs Any insurance recovery reduces the deduction dollar for dollar.
The burden of proof is entirely on you. The IRS will disallow the deduction if you cannot show the destruction actually happened, and relocating goods to another storage facility does not count. A certificate of destruction from a third-party service is the strongest evidence. If you destroy goods in-house, keep dated photographs, written descriptions of what was destroyed, and signed statements from at least two independent witnesses.
Donating the Inventory
Charitable donations of inventory are deductible under IRC Section 170, and the recipient must be an organization recognized as tax-exempt under IRC Section 501(c)(3).4Office of the Law Revision Counsel. 26 US Code 501 – Exemption From Tax on Corporations, Certain Trusts, Etc.5Office of the Law Revision Counsel. 26 US Code 170 – Charitable, Etc., Contributions and Gifts Inventory is ordinary income property for most businesses, and the standard deduction is limited to the goods’ cost basis, meaning the lower figure after any GAAP write-down.
C corporations (not S corporations) can claim an enhanced deduction under IRC Section 170(e)(3) when they donate inventory that the charity uses directly for the care of the ill, the needy, or infants.6Internal Revenue Service. In-Kind Contributions – Section: The IRC 170(e)(3) Exception The deduction can rise above basis, up to basis plus half the difference between fair market value and basis, and it cannot exceed twice the basis. The charity must confirm the qualifying use in writing.
Documentation requirements scale with value. Every donation needs a written acknowledgment from the charity describing the property. If the claimed value exceeds $500, file IRS Form 8283 with your return. If it exceeds $5,000, get a qualified independent appraisal and complete Section B of Form 8283.7Internal Revenue Service. Instructions for Form 8283 (Rev. December 2025) Missing the appraisal on a high-value donation is a common way to lose the deduction on audit.
An older enhanced deduction for donations of computer equipment for educational use was repealed in 2014 and is no longer available.
The 2026 Corporate Deduction Floor
For tax years beginning after December 31, 2025, the One Big Beautiful Bill Act changed the corporate charitable deduction cap. Corporations previously deducted charitable contributions up to 10% of taxable income with no minimum. Starting in 2026, contributions are deductible only to the extent they exceed 1% of taxable income, and the 10% ceiling still applies.8Office of the Law Revision Counsel. 26 USC 170 – Charitable, Etc., Contributions and Gifts
The first 1% of taxable income spent on charitable giving is now non-deductible. A corporation with $2 million in taxable income donating $80,000 of inventory can deduct $60,000, which is the amount above the $20,000 floor. Contributions above the 10% ceiling still carry forward for up to five years.
The floor does not apply to pass-through entities. S corporations, partnerships, and sole proprietorships apply charitable limits at the owner level under separate individual rules.
Simplified Rules for Small Businesses
Not every business has to run the full inventory accounting framework. Under IRC Section 471(c), businesses with average annual gross receipts of $31 million or less over the prior three tax years can elect simplified inventory methods, with the threshold adjusted annually for inflation.9Internal Revenue Service. Publication 334 (2025) – Tax Guide for Small Business
Two options are available. Under the non-incidental materials and supplies method, you treat inventory as materials and supplies and deduct the cost in the year you provide the goods to your customers. Under the financial accounting conformity method, you follow the inventory method used in your applicable financial statements or internal books and records. Either approach eliminates formal year-end LCNRV impairment testing. Switching to a simplified method requires filing Form 3115, Application for Change in Accounting Method.
Documentation the IRS Expects
Every disposal path needs a paper trail connecting the impairment assessment to the final removal of the goods. Auditors look for gaps, and a missing link can cost you the deduction.
For the impairment side, keep inventory aging reports, the net realizable value calculation with the market data or broker quotes behind it, and a signed management authorization listing the specific inventory lines and dollar amounts.
For the physical disposal, records differ by method:
- Liquidation: sales contracts, invoices, payment receipts, and a reconciliation showing proceeds recorded as revenue.
- Donation: written acknowledgment from the 501(c)(3), Form 8283 (with a qualified appraisal if the claimed value tops $5,000), and, for the enhanced deduction, the charity’s written confirmation of qualifying use.7Internal Revenue Service. Instructions for Form 8283 (Rev. December 2025)
- Destruction: a certificate of destruction from a third-party service, or internal records including dated photographs, item descriptions, quantities, and signed witness statements.
Your inventory sub-ledger should also reconcile cleanly to the general ledger, showing that the disposed items were removed from the books and the loss was recorded in the correct period. Without that cross-reference, even well-documented destruction can be hard to defend on examination.
Environmental Rules Can Change the Math
The tax rules assume you can legally destroy the goods. Environmental law is a separate layer, and for certain products it can flip the economics of your disposal decision. Under the Resource Conservation and Recovery Act, businesses that generate hazardous waste during destruction are classified into EPA generator categories by monthly volume, and small and large quantity generators must track shipments under the federal manifest requirements of 40 CFR Part 262.10US EPA. Categories of Hazardous Waste Generators11US EPA. Resource Conservation and Recovery Act (RCRA) Regulations
Electronics containing lead, mercury, or cadmium often qualify as hazardous waste when disposed of.12US EPA. Regulations for Electronics Stewardship Compliance costs can be substantial, and fines for non-compliance can dwarf any deduction the destruction produces. Donating the goods to a qualified recycler or charity, when the recipient can actually use them, sometimes eliminates both the compliance burden and the disposal expense while still delivering a tax benefit.