Tax Season - Hobby Profit vs Expenses - Help, please

[gov.broadside]

Okay, so, I've been buying and selling vintage Lego on Ebay for many years. It's just a hobby, and I'm not out to make money. I'm just trying to maintain my hobby - a hobby that I could never maintain without also selling parts. Being creative and detail-oriented, I really enjoy purchasing huge lots, cleaning them, breaking them down, sorting them into categories, dividing them into smaller lots, and selling them. This has always been a slow, relaxing process, and I've never made much in a year. The sales are barely, if any, higher than the expense, so the profit (if it even exists) is basically negligible.

But, since I have now surpassed $600 in sales (not profit) this year, Ebay will be sending me the 1099 form next year. Obviously, I shouldn't pay taxes on my sales, since almost none of it is profit/income. So, I'm told "No big deal, just fill out Schedule C and deduct your expenses." Here's the problem - the way I buy massive piles of pieces and break them up, it's not just difficult, it's literally impossible to determine the exact expense of the lots I sell. Not unless I kept track of every single piece, which there are tens of thousands. I have an enormous pool of grouped parts I'm adding to and pulling from constantly, most of the pieces spanning multiple years before getting from point A to point B. So, it is clearly not as simple as "bought this for this much, and sold it for this much."

Now, I've also read in various places, "Just take your total expenses for that year and your total sales." Great! This sounds much nicer; but again, since most things span multiple years, there may be one year when I buy $2,000 worth of Lego, and another where I only buy $200, and the sales fluctuate all over the place. Some years it might be way more than expense, other years, way less than expense. So, is this true? Can I just take the total expense and total sales of everything I've bought and sold that year, regardless of how imbalanced they are? Or do I actually need to keep detailed track of every tiny part of every transaction (which, again, is completely impossible for a human brain to manage and document). I use multiple platforms for stocking up, but I sell exclusively on Ebay. Keep in mind, this is a hobby - I do it because I love it, not because I'm trying to make money. I just make an effort to cover costs as best I can. I've never felt an ounce of extra padding in my wallet because of it.

Does anyone in a similar situation know the correct way to handle this. Sorry if I sound ignorant - this has just never been an issue for me before, because up to this point the IRS hadn't decided that they wanted to take all the joy out of my hobby, haha. My head hurts just thinking about all this, my goodness.

Thanks friends...

[gov.broadside]

Ha, yeah, I understand that the example is absurd - but that's what it would take if I needed to know how much of each expense was related to each sale, outside of guesswork.

Adding up yearly totals sounds much more pleasant (wiping away sweat).

Thanks again for your help. I'll double check specifics relating to my circumstance, but your input is helpful and much appreciated!

[mr_lincoln]

@gov.broadside   Any time ...

[bashort]

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@mr_lincoln wrote:

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@gov.broadside wrote:

Thank you, and right - I have just such a spreadsheet. It's easy to add up yearly totals, I don't have a problem with that. I'm just trying to figure out if yearly totals based on everything combined is actually what is needed, as opposed to adding up expenses and sales for each item, because that's where it gets hairy - or rather impossible, considering how many purchased lots (some several years old) I might be pulling parts from to create a single lot of my own. It's like pouring 50 different sized glasses or pitchers of water into a tub, then occasionally filling a cup of my own out of that tub and trying to figure out which drops came from which glass, when, and how much. So, do I have to keep track of my "water droplets"? Or can I just say, "I made this much this year, and I spent this much"?

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@gov.broadside    Basically that is correct, the Schedule C only asks for totals in each field.  Your job is to provide some type of support documentation for how you arrived at those individual totals.  Any left over inventory would be more of an estimate then a hard number ... I have to do the same with what I sell.  I might buy 30 train cars and locomotives for "X" but sell them individually ... that original "X" for all of them was NOT broken down as purchased, that info does not exist.  Like one of your big boxes of Legos ... the box cost "X" ... the individual break down of what each little piece cost does not exist, period.

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I have "so far" managed to sell my very last item on 12/31 every year thus thankfully not having to do a inventory.

[mr_lincoln]

@bashort   wrote: "I have "so far" managed to sell my very last item on 12/31 every year thus thankfully not having to do a inventory."

Good for you, THAT is a perfect world in some respects ... I wish I could say the same ...

[bashort]

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@mr_lincoln wrote:

@bashort   wrote: "I have "so far" managed to sell my very last item on 12/31 every year thus thankfully not having to do a inventory."

Good for you, THAT is a perfect world in some respects ... I wish I could say the same ...

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That is my story and I am sticking with it.

Seriously though, I buy items in large quantities that are usually a jumbled mess, then bring them in, sort them out, trash some, sell some for scrap metal, and sell some on ebay. it would be practically impossible for me to do a actual inventory. My tax preparer told me that it would likely not be a problem to not carry inventory as long as you sold more every year than you bought. 

[wildpitchsports]

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@mr_lincoln wrote:

@bashort   wrote: "I have "so far" managed to sell my very last item on 12/31 every year thus thankfully not having to do a inventory."

Good for you, THAT is a perfect world in some respects ... I wish I could say the same ...

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I sold my last one on 12/26 so not a dime carried over as well 😎

[dbfolks166mt]

     I do pretty much the exact same thing you do and like you I find it relaxing and a challenge. First a lot of people have a misunderstanding of what inventory is. I utilize accrual accounting for tax reporting purposes which means I recognize expenditures and revenues when they are occur irrespective of the cash flow. The IRS does not really care about what is encapsulated in the items you sell only what the revenues were from the sale at a macro level. The same applies to expenditures. They want the big picture and expenses from one year may not necessarily be covered by revenues from the same year but the IRS really does not care. So the lots I buy are recognized as an expense or COGS in their entirety when the expense occurs. Revenues which may or may not include parts/pieces from any given lot are recognized when they occur. 

     A lot of people assume that what they have on the shelf is inventory from a tax perspective when in fact it is not. Inventory from a tax perspective relates to the tangible property of a business. In essence the furniture, buildings, vehicles that a business "owns" and uses to operate its business. It is not items they have that they are going to sell. Inventory is also what businesses generally use to write off depreciation expenses against that property using a number of methods including straight line, declining balance, sum-of-the-years and a couple others. Most of the sellers on eBay do not have to worry about either inventory or depreciation. If you are going to report inventory and depreciation you probably are going to need an accountant and/or a tax professional. 

[mr_lincoln]

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@bashort wrote:

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@mr_lincoln wrote:

@bashort   wrote: "I have "so far" managed to sell my very last item on 12/31 every year thus thankfully not having to do a inventory."

Good for you, THAT is a perfect world in some respects ... I wish I could say the same ...

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That is my story and I am sticking with it.

Seriously though, I buy items in large quantities that are usually a jumbled mess, then bring them in, sort them out, trash some, sell some for scrap metal, and sell some on ebay. it would be practically impossible for me to do a actual inventory. My tax preparer told me that it would likely not be a problem to not carry inventory as long as you sold more every year than you bought. 

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@bashort   The only place you will notice any issues is your 1099K from eBay (if you get one) will only reflect sales up to "about" the last week of the year (they have more specific guidelines then that but yours truly is not going there) ... so some of your year end sales will roll over into the following year ... But that's not a deal breaker, just something to adjust to at tax time ...

[mr_lincoln]

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@wildpitchsports wrote:

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@mr_lincoln wrote:

@bashort   wrote: "I have "so far" managed to sell my very last item on 12/31 every year thus thankfully not having to do a inventory."

Good for you, THAT is a perfect world in some respects ... I wish I could say the same ...

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I sold my last one on 12/26 so not a dime carried over as well 😎

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Yes, I really wish I could say the same @wildpitchsports ... doing the inventory end is a pain ...

[mega-ma-roo]

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@mr_lincoln wrote:

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@wildpitchsports wrote:

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@mr_lincoln wrote:

@bashort   wrote: "I have "so far" managed to sell my very last item on 12/31 every year thus thankfully not having to do a inventory."

Good for you, THAT is a perfect world in some respects ... I wish I could say the same ...

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I sold my last one on 12/26 so not a dime carried over as well 😎

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Yes, I really wish I could say the same @wildpitchsports ... doing the inventory end is a pain ...

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As a small business owner (I'm guessing your revenues are a bit under $26 million a year and you are not a tax shelter 😀), you don't need to keep an inventory. 

Publication 334 (2021), Tax Guide for Small Business | Internal Revenue Service (irs.gov)

If you are a small business taxpayer, you can choose not to keep an inventory, but you must still use a method of accounting for inventory that clearly reflects income. If you choose not to keep an inventory, you won’t be treated as failing to clearly reflect income if your method of accounting for inventory treats inventory as non-incidental material or supplies, or conforms to your financial accounting treatment of inventories.

You can use Form 3115 to change from accrual to cash accounting.

[luckythewinner]

Here is essentially what I do.

Treat you LEGO parts as homogeneous commodities.

If you bought 50 lots of 1000 LEGO parts in 2020 for $500, keep the receipts/eBay transactions to document the fact that you bought 50,000 LEGO parts at 1 cent each.

If you bought 20 lots of 2000 LEGO parts in 2021 for $1000, keep the receipts/eBay transactions to document the fact that you bought 40,000 LEGO parts at 2.5 cent each.

Thus your unofficial inventory says you have: 

2019 LEGOs:  50,000 @ 1 cent = 50,000 remaining

2020 LEGOs:  40,000 @ 2.5 cent = 40,000 remaining

Then as you sell lots of LEGOs, deduct the average cost per piece using a "first in, first out" approach.

Example 1:

If you sold 50 lots of 500 LEGOs in 2021, you would subtract 25,000 LEGOs from your 2019 inventory and expense them at 1 cent each for a total Cost of Goods Sold of $250 (1 cent each).

At the end of the year, your unofficial inventory says you have: 

2019 LEGOs:  50,000 @ 1 cent = 25,000 remaining

2020 LEGOs:  40,000 @ 2.5 cent = 40,000 remaining

Example 2:

If you sold 30 lots of 2,000 LEGOs in 2021, you would subtract 50,000 LEGOs from your 2019 inventory and expense them at 1 cent each for a total Cost of Goods Sold of $500. You would also subtract 10,000 LEGOs from your 2020 inventory and expense them at 2.5 cent each for a total Cost of Goods Sold of $250.

At the end of the year, your unofficial inventory says you have: 

2019 LEGOs:  50,000 @ 1 cent = 0 remaining

2020 LEGOs:  40,000 @ 2.5 cent = 30,000 remaining

You report all this on Schedule C.

The good news is that you do not need to value or track your unsold inventory on your tax return. Read IRS publication 334 under the section "Treating inventory as non-incidental material or supplies". 

This is why I call your LEGO parts "unofficial inventory" - because you do not deduct the expense until the year that you actually sell them per Publication 334.