What expense category is Construction Materials?

For any construction business, the cost of materials—from lumber and concrete to wiring and fixtures—is the single largest direct cost of completing a job. Unlike general office supplies, these materials are not a simple operating expense. Instead, they are a fundamental component of your Cost of Goods Sold (COGS).

Understanding how to correctly account for construction materials within the COGS framework is essential for accurately calculating your gross profit and ensuring your tax filings are compliant with IRS rules. This guide will break down how to categorize these direct costs and the key accounting principles you must follow.

Construction Materials (as Direct Costs/COGS) Category

The costs of construction materials are not deducted as a standalone expense. Instead, they are included in the Cost of Goods Sold calculation, which is reported in Part III of Schedule C (Form 1040).

Specifically, the cost of raw materials and parts purchased for a construction project is included on Line 36, Purchases, within the COGS section. This is because, for a construction business, these materials are the equivalent of inventory or stock in trade for a retailer.

Important Considerations While Classifying Construction Materials

To correctly calculate your COGS, you must accurately track material costs and understand the specific IRS rules that apply to producers of property.

Direct vs. Indirect Costs

It is crucial to distinguish between direct and indirect materials.

• Direct Materials: These are the materials that physically become part of the finished project (e.g., lumber, drywall, piping). Their cost is included in your COGS.
• Indirect Materials and Supplies: These are items used in the construction process but do not become part of the final product (e.g., small tools, cleaning supplies, safety gear). As explained in IRS Publication 334, these are typically deducted as Supplies on Line 22 of Schedule C, not included in COGS.

The Uniform Capitalization Rules

As a business that produces real property, construction companies are subject to the uniform capitalization rules detailed in IRS Publication 535. This means you must capitalize not only the direct costs of materials but also a portion of your indirect costs. Indirect costs that must be added to the basis of the property you produce (and thus included in COGS) can include:

• Storage and warehousing costs for materials.
• Rent on equipment and facilities used for the project.
• Certain administrative costs.

Small business taxpayers with average annual gross receipts of $27 million or less (for the 3 prior tax years) are generally exempt from these rules.

Inventory and Accounting Methods

IRS Publication 334 states that when the production or sale of merchandise (or a constructed asset) is an income-producing factor, you must generally use an accrual method of accounting for your purchases and sales and must account for inventory. This means tracking the cost of materials on hand at the beginning and end of the year to accurately calculate your COGS.

Tax Implications and Recordkeeping

Your gross profit is calculated by subtracting your total COGS from your gross receipts. Therefore, accurate material cost tracking is essential for correct tax reporting.

How to Report the Costs

For a sole proprietor filing a Schedule C (Form 1040), construction materials are a key part of the COGS calculation in Part III:

• The cost of materials purchased during the year is included on Line 36, Purchases.
• The value of materials on hand at the start and end of the year is reported on Line 35 (Inventory at beginning of year) and Line 41 (Inventory at end of year).

What Records to Keep

You must have documentary evidence to substantiate all material costs. Your records should include:

• Invoices from all suppliers and vendors.
• Purchase orders.
• Proof of payment, such as canceled checks or credit card statements.
• Accurate inventory records detailing materials on hand.

How Fyle Can Automate Expense Tracking for Construction Materials

Fyle helps you capture and organize the high volume of material purchases for every job, providing a clear and compliant record for your COGS calculation.

• Capture Invoices on the Go: Snap pictures of receipts from supply houses or attach vendors email invoices to Fyle for automatic capture.
• Track by Job Site: Code every material purchase to a specific project or job number for precise cost allocation and profitability analysis.
• Centralize All Documents: Keep purchase orders, invoices, and proofs of payment together in one easily accessible digital record.
• Automate Your Accounting: Sync categorized material costs directly to your Purchases or COGS account in QuickBooks, Xero, NetSuite, or Sage Intacct.