Have a knack for finding deals? Turn your shopping habit into a retail arbitrage business and turn a profit by reselling trendy items at a higher price. In this guide, we dish out accounting and business best practices for a resale business.
In this article:
- What does retail arbitrage mean?
- Difference between retail arbitrage vs online arbitrage
- Is retail arbitrage legal?
- Product restrictions and brand-gated products
- Bookkeeping and taxes for retail arbitrage
What Does Retail Arbitrage Mean?
Arbitrage in a traditional sense is profiting off micro fluctuations in pricing. Essentially it is an asset purchased at a low price in one market that is resold in another market for a higher price. Retail arbitrage applies this tactic specifically to goods and commerce. It is a business model that revolves around buying cheap products in stores or online, then reselling them for slightly more in online marketplaces.
It is a popular side hustle that can be started with a small amount of capital. Although it isn’t as easy as it sounds, not everything sells, and markets like Amazon and eBay are very competitive. To maximize profits you need to be ahead of consumer trends, know your target audience, and have a good stronghold in accounting.
Retail Arbitrage Sourcing And Storage
Flipping is the dominant method for earning sales in retail arbitrage. To have a successful flip, you need to explore retail arbitrage sourcing. Generally, resellers find discount products from physical stores or virtual retailers. Building up inventory with small-batch purchases gives your store a varied selection for customers to choose from. Once you discover a good product-market fit, invest in larger quantities via wholesale purchases.
Storage is a factor in a retail arbitrage business. Many retail arbitrage sellers start with purchases from brick and mortar stores and run the business out of the garage. As sales pick up and inventory increases a fulfillment center is the next logical step. With an Amazon FBA online arbitrage setup, you can transfer straight from your vendors to your warehouse.
Is Retail Arbitrage Legal?
It is not illegal to sell a product you own. But in retail arbitrage you don’t own any part of the product so where does that leave you?
Yes, retail arbitrage is legal, but reselling must be handled with care. Some brands only permit authorized resellers to market their items. When you are purchasing products from vendors, get their seal of approval. This is generally proof of a wholesale purchase directly from the brand + a resale certificate.
Products that have notices like “not for resale” are off-limits unless you get permission. In addition, certain categories and products are brand-gated, meaning they have a steel lock that prevents reselling. Never resort to reverse passing-off, ie. removing a brand’s trademark, without consent, to sell a product unbranded or portray it as your own.
Note: check a product before you make an inventory purchase. For Amazon surf thru Amazon Sellers Central to get the scoop on restricted and gated brands. Put up a test product listing to see if it requires resellers approval.
Do I Need A License For Retail Arbitrage?
No, you do not need to have a business license for retail arbitrage. When you are just starting this will likely be passive income, and won’t demand the legitimacy of registering.
Keep in mind with high sales volume, you could cross over sales tax thresholds. In that case, you will need a sales tax license to legally collect and remit sales tax. For a sales tax license, your retail arbitrage business needs to be registered.
Here are 3 due diligence items for retail arbitrage, to ensure you err on the good side of the law:
- Employer Identification Number (EIN) – Apply for an EIN to certify your business entity. It is a number issued by the IRS that identifies your business for federal and state tax purposes. You need this for reselling activities like getting inventory through customs, applying for a sales tax permit, opening certain merchant accounts, and employing workers.
- Sales Tax License – Get a sales tax license in your home state. Each state has a sales tax threshold for collecting and remitting sales tax. Depending on the state, a sales tax license will allow you the right to resell products.
- Resale Certificate – A resale certificate allows you to escape paying sales tax on inventory items because you will collect the tax from your consumers at a future date. Whether a company accepts your resale permit is up to them, since the sales tax could become their liability if the products aren’t resold. For items you don’t end up selling, if you purchased with a resale certificate, you will owe use tax.
Bookkeeping And Taxes For Retail Arbitrage
Running a reseller eCommerce business means there will be doing bookkeeping and taxes. Here is how to start your backend off right:
Business accounts should be separate from personal accounts, retail arbitrage is no exception. What’s the harm in charging your latest find on your personal card? Well, come tax time you will be sifting through all your purchases to pull out ones related to the business. This takes time and makes for a stressful tax season.
Instead have a business card for purchases and an accounting system to organize purchases into different accounts. A cloud-based accounting software system will centralize COGS, marketplace expenses, reselling fees, sales tax, and other operating costs. By categorizing transactions you have a better sense of profitability month over month and year or year.
Get a Xero plan for an intuitive accounting system. It is quick to enroll and easy to connect applications to support all your eCommerce needs.
You will likely be selling in a couple of different marketplaces. With a cloud-based accounting system, you can integrate your sales channels via a bridge tool. Bridge tools ease manual accounting tasks with batch settlement statements. Batch settlements reduce common mistakes that happen when reconciling transactions and selling in multiple currencies.
Keep inventory in a separate account so it is reflected as an asset on your balance sheet. As your products are purchased, inventory can be expensed in direct correlation to the amount purchased. This allows you to deduct any unsold inventory at the end of the year. It will also help you visualize which SKUs are costing you money by sitting on shelves..
Retail Arbitrage Taxes
Your tax rate will depend on how you classify the income. When you first start reselling, earnings could be considered other income if they don’t fall into the definition of self-employment activity.
Self-employment activity: done with the intent to make income or profit and is any activity that you engage in regularly, not sporadically.
Other income is only subject to income tax, not self-employment tax (SE Tax). So if your sales activity is more of a hobby, and isn’t regular enough to be considered business income, call it other income. With this designation, you may only deduct expenses equal to the amount of income you claim.
As sales become more regular, retail arbitrage activity is business income. It is highly likely you will register as a pass-through business entity, and that means you will be reporting any gain or loss from your retail arbitrage business to your individual tax return. In this scenario, you will owe self-employment taxes.
Business Expense Deductions For Retail Arbitrage
To minimize the effect of SE taxes on your business, you need to reduce your taxable income. This will be done by deducting expenses. Here are the most common expense deductions for retail arbitrage:
- Cost of Goods Sold (COGS)
- Advertising costs
- Marketplace fees
- Business registration fees
- Bank fees
- Home office
- Office expenses
- Mileage and automobile expenses
How Do I Calculate COGS For Retail Arbitrage?
Cost of Goods Sold (COGS) for retail arbitrage is calculated to deduct your product’s costs on taxes. The calculation measures the difference between your buy price and sale price. To calculate COGS you use this formula:
COGS = Beginning Inventory + Purchase – Ending Inventory
Since you don’t make the products, you determine your purchase figure by adding your buy price and landed costs. Your buy price is how much you purchased the products for, and your landed costs are everything that goes into preparing it to sell. Landed costs include items like wholesale fees, shipping + handling, customs fees, import taxes, procurement, stocking, and storage fees.
To solve the equation you will need to find the beginning and ending inventory values. To do that you need to choose an inventory cost method and count your units.
It is not often that we recommend a cost method other than the average cost method (AVCO). For a small retail arbitrage venture, it will suffice. AVCO lets you take the average costs of your units to simplify your accounting.
However in a large-scale retail arbitrage operation, with a high volume of sales, it is advantageous to use the Last In First Out (LIFO) cost method. LIFO doesn’t mean that you are literally selling your newest items first, only that for tax purposes you value your newest items at a higher price versus your older items. This will result in higher COGS expenses but a lower net income, reducing the amount of taxes you pay.
In retail arbitrage the longer you hold onto items, the less they are worth. Since you are buying inventory that quickly depreciates from fading trends, expiration dates, etc, calculating your beginning and ending inventory value with LIFO helps to account for anticipated revenue loss.
Note: the LIFO cost method has complexities that demand an accountant.
It All Adds Up
With retail arbitrage you have very little control over your product. So it is imperative to reduce expenses where you can to increase profit margins. Use our tips and you are sure to succeed with this side-hustle. If you need help with accounting and taxes we are here to help.