Yes. Freight you pay to bring purchased goods into your warehouse is included in inventory cost, not expensed immediately. Under GAAP, inventory is carried at the cost to bring it to its “present location and condition,” and Treasury Regulation 1.471-3 requires the cost of purchased merchandise to include the invoice price plus “transportation or other necessary charges incurred in acquiring possession of the goods.”1GovInfo. Treasury Regulation 1.471-3 – Inventories at Cost That freight sits inside the inventory account on your balance sheet until the product sells, at which point it moves to cost of goods sold and reduces taxable income. Outbound shipping to your customers is a different animal and does not go into inventory.
What Inbound Freight Costs Get Capitalized
The costs that get folded into inventory, collectively called freight-in, are the ones the buyer pays to take delivery of purchased goods. They typically include:
- Carrier charges for trucking, rail, ocean, or air freight from the supplier
- Transit insurance premiums covering damage or loss in shipment
- Customs duties, tariffs, and brokerage fees on imports
- Dock, palletizing, and terminal handling fees at ports or distribution centers
A quick example. You order 500 units at $20 each for $10,000, and you pay $750 in freight plus $250 in cargo insurance. Total inventory cost is $11,000, so each unit is worth $22 on your books instead of $20. Sell 100 units and $2,200 moves to cost of goods sold, not $2,000. The freight has not disappeared; it waited inside inventory until a sale showed up to match against.
One nuance trips people up. Abnormal freight is not capitalized. If a natural disaster forces you to reroute shipments through a much more expensive path, or you are shuttling goods between warehouses because of an unplanned shutdown, those charges are expensed in the current period. Routine price surges, even steep ones caused by broad supply chain disruptions, are still considered normal and still belong in inventory.
Shipping Terms Decide Who Capitalizes the Freight
Whether the freight is yours to capitalize in the first place depends on the shipping terms in your purchase contract.
Under FOB Shipping Point (sometimes written FOB Origin), ownership transfers to the buyer the moment the seller hands the goods to the carrier. From that point the buyer owns the goods, bears the risk of loss or damage in transit, and capitalizes all freight. The inventory also lands on the buyer’s balance sheet on the ship date, not the delivery date. If your fiscal year closes while goods are in transit under FOB Shipping Point, those goods belong on your year-end balance sheet even though the truck has not arrived. Missing that understates ending inventory, overstates cost of goods sold, and distorts the return.
Under FOB Destination, the seller keeps ownership until the goods reach the buyer’s location. The buyer records nothing until delivery is complete and books the goods at the invoiced price. Any shipping the seller pays is the seller’s cost.
International purchases usually run on Incoterms rather than FOB, and they range widely. Under EXW (Ex Works), the buyer takes on virtually every logistics cost from the seller’s front door onward: inland transport, export clearance, ocean or air freight, customs duties, final delivery. All of it capitalizes into the buyer’s inventory. Under DDP (Delivered Duty Paid), the seller handles freight, insurance, customs, and duties all the way to the buyer’s designated location, so the buyer’s inventory cost is simply the agreed purchase price.2ICC Academy. Incoterms 2020: EXW or DDP? Terms like CIF sit between the two. The rule stays constant across all of them: whatever freight, duty, and insurance the buyer actually pays becomes part of inventory cost, and import tariffs are treated no differently from a domestic trucking bill.1GovInfo. Treasury Regulation 1.471-3 – Inventories at Cost
Outbound Freight to Customers Is Not Inventory
Freight-out, the cost of delivering sold products to your customers, never gets capitalized. The goods have already left inventory, so there is no asset to attach the cost to. Freight-out is a selling expense recognized on the income statement in the same period as the sale, typically as a line below gross profit. Lumping outbound delivery into inventory inflates your assets and misstates your gross margin, and it is one of the more common classification errors that surfaces during year-end audits or when a lender first reads the financials closely.
Section 263A and the Small Business Exemption
For tax purposes, the obligation to capitalize freight goes beyond the general rule. Section 263A of the Internal Revenue Code, known as the Uniform Capitalization rules or UNICAP, requires businesses that produce or resell merchandise to include both direct costs and a proper share of indirect costs in inventory.3Office of the Law Revision Counsel. 26 USC 263A – Capitalization and Inclusion in Inventory Costs of Certain Expenses Freight is one of the most common indirect costs subject to UNICAP, along with warehousing, purchasing-department overhead, and handling labor.
Smaller businesses get a meaningful break. If your average annual gross receipts over the prior three tax years do not exceed $32 million for tax years beginning in 2026, you are exempt from UNICAP entirely.4Internal Revenue Service. Revenue Procedure 2025-32 This small business taxpayer exemption, established by the Tax Cuts and Jobs Act under Section 471(c), lets qualifying businesses follow their regular financial accounting method for inventory without the extra UNICAP allocation math.5Office of the Law Revision Counsel. 26 USC 471 – General Rule for Inventories The threshold adjusts for inflation, so confirm the current figure in the IRS’s annual revenue procedure.
If UNICAP does apply, the computation goes well beyond adding a freight bill to the purchase price. You allocate a share of indirect costs to inventory using an IRS-approved method, typically the simplified production method for manufacturers or the simplified resale method for retailers and wholesalers. Doing the calculation incorrectly, or skipping it when required, is a recurring issue in IRS examinations of inventory-heavy businesses.6Internal Revenue Service. Lower of Cost or Market (LCM)
When Capitalized Freight Actually Hits Your Income Statement
Once freight is baked into per-unit inventory cost, the timing of when it reaches cost of goods sold depends on your cost-flow method.
Under FIFO (first in, first out), the oldest inventory layers are treated as sold first. Freight from your earliest purchases flows to cost of goods sold before freight from more recent purchases. In a period of rising shipping rates, FIFO leaves the higher recent freight costs sitting in ending inventory while the lower, older costs reduce current taxable income.
LIFO (last in, first out) works the opposite way. The most recently purchased inventory, carrying the latest freight costs, is treated as sold first. In a rising-freight environment, LIFO pushes higher costs to the income statement sooner, reducing current-year taxable income and leaving older, cheaper layers on the balance sheet.
Neither method changes the total freight you will eventually expense. It only changes the year the expense lands in. During volatile freight periods, the spread between the two methods can meaningfully shift the tax bill from one year to the next.
Where Freight Goes on Form 1125-A
Businesses filing Form 1120, 1120-S, or 1065 report inventory costs on Form 1125-A (Cost of Goods Sold). Freight-in typically appears in one of two places on that form:
- Line 2 (Purchases), where freight is bundled into the total acquisition cost of inventory
- Line 4 (Additional Section 263A Costs), where businesses using a UNICAP simplified method separately report capitalizable costs like transportation and handling7Internal Revenue Service. Form 1125-A Cost of Goods Sold
Classification matters because the IRS cross-checks the relationship among purchases, beginning inventory, ending inventory, and cost of goods sold. If those numbers do not reconcile, for instance because freight was expensed on the income statement but not reflected in the inventory change, the return can flag for review. Keep freight invoices and bills of lading tied to specific purchase orders so the numbers are easy to support if questions come up.
What Happens If You Get It Wrong
Miscategorizing freight, whether by expensing it immediately instead of capitalizing it or leaving it out of inventory entirely, understates assets and overstates deductions. If that error causes a meaningful underpayment of tax, the IRS can impose accuracy-related penalties under Section 6662.8Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments
The standard penalty is 20% of the underpayment caused by negligence or a substantial understatement of income tax. For a gross valuation misstatement, where the reported value is off by 200% or more from the correct amount, the penalty doubles to 40%. For substantial valuation misstatements specifically, the penalty applies only when the resulting underpayment exceeds $5,000, or $10,000 for C corporations.8Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments
The IRS can also force a change to your accounting method going forward if it determines your inventory approach does not clearly reflect income. A forced method change usually requires a Section 481(a) adjustment, a catch-up calculation that brings cumulative inventory balances in line with the correct method. For a business that has been misclassifying freight for several years, that one-time adjustment can be substantial.