If your sole trader business makes a loss, you can still use the cash basis to report it. The cash basis is not restricted to profitable years. But the interaction between the cash basis and loss relief rules is where things get specific. Get it wrong and you could miss out on tax relief worth thousands of pounds.

This article explains how the cash basis works with losses for the 2025/26 tax year, which loss relief options are available, and what you need to tell HMRC.

What Is the Cash Basis for Sole Traders?

The cash basis is a simplified accounting method for sole traders and partnerships. You record income when you actually receive it and expenses when you actually pay them. No accruals, no debtors, no creditors. It is the default method for sole traders from 2024/25 onwards, unless your turnover exceeds £150,000 (or £300,000 in some transition cases) or you actively opt out.

Under the traditional accruals basis, you record income when you invoice it and expenses when you incur them, regardless of when cash changes hands. The cash basis is simpler, but it can produce different profit or loss figures in any given year.

For a sole trader running a consultancy in Manchester's Northern Quarter, the difference is clear. If you issue a £5,000 invoice in March 2026 but the client pays in May 2026, the cash basis records that income in 2026/27. The accruals basis records it in 2025/26. That timing difference matters when you are trying to work out whether you have a loss.

Can You Use the Cash Basis With a Loss?

Yes. There is no rule that says you must switch to accruals accounting just because you have made a loss. HMRC accepts the cash basis for loss-making years in exactly the same way as for profitable years.

However, you need to be careful about one thing. If your business has made losses in several consecutive years, HMRC may question whether you are genuinely trading. That is a separate issue from the accounting method. But if you are trading with a genuine intention to make a profit, and the losses are temporary or part of a startup phase, the cash basis is fine.

As ICAEW qualified accountants, we see this most often with new sole traders in their first year. A freelance graphic designer in Shoreditch might spend £8,000 on a new MacBook, software licences, and website costs before earning a single invoice. That first year loss is perfectly normal, and the cash basis handles it cleanly.

How Loss Relief Works Under the Cash Basis

The loss relief rules work the same way regardless of whether you use the cash basis or accruals basis. The loss figure itself is calculated differently, but once you have that figure, the relief options are identical.

Your main options for a sole trader loss in 2025/26 are:

  • Carry the loss forward against future profits from the same trade. This is automatic. You do not need to claim it. The loss is deducted from your first available profits in later years.
  • Claim loss relief against other income (also called sideways relief or s.64 ITA 2007). You offset the loss against your total income for the same tax year, or the previous tax year. This can generate a tax refund.
  • Claim early trade loss relief (s.72 ITA 2007). If your loss arises in the first four tax years of trading, you can offset it against your total income in the three years before the trade started. This is useful for new businesses.
  • Claim terminal loss relief if you cease trading. The loss in your final 12 months can be offset against profits from the same trade in the previous three tax years.

Each option has different rules about timing, amounts, and whether you can restrict the claim. The cash basis does not change any of these rules.

Worked Example: Cash Basis Loss Relief

Let us use a real example. A self-employed plumber in Leeds runs a sole trader business. In 2025/26, his cash basis accounts show:

  • Income received: £28,000
  • Expenses paid: £36,400
  • Loss: £8,400

He also has a part-time employed job earning £22,000 per year. He can claim sideways relief under s.64 ITA 2007 to offset the £8,400 loss against his employment income for 2025/26. That reduces his total income to £13,600. His personal allowance of £12,570 means he only pays tax on £1,030. He gets a refund of the tax already deducted from his employment pay.

If he had used the accruals basis, his loss might have been different. Perhaps he invoiced £4,000 in March 2026 that was not paid until May 2026. Under accruals, that £4,000 counts as income in 2025/26, reducing the loss to £4,400. Under cash basis, it is not income until 2026/27, so the loss stays at £8,400. The cash basis loss is larger in this case, giving him more relief now.

That is the key point. The cash basis can produce a larger loss in some years and a smaller loss in others, depending on the timing of receipts and payments.

Cash Basis Loss and Capital Allowances

Under the cash basis, you cannot claim capital allowances on most assets. Instead, you deduct the full cost of plant and machinery as an expense in the year you pay for it. This includes laptops, tools, vans, and equipment.

If you buy a van for £18,000 in 2025/26, you deduct the full £18,000 as an expense in that year under the cash basis. Under accruals, you would claim capital allowances, typically Annual Investment Allowance at 100% for the first £1,000,000, but the principle is the same. The difference is that capital allowances require a specific claim on your tax return, while the cash basis just treats it as an ordinary expense.

This means the cash basis can create larger losses in years where you invest heavily in equipment. A sole trader electrician in Birmingham's Jewellery Quarter might buy £12,000 of new tools and a £15,000 van in one year. Under the cash basis, that is £27,000 of expenses immediately. Under accruals, you might spread some of that through writing down allowances if you opted out of AIA, but most sole traders using accruals would claim AIA anyway. The net effect is often similar, but the cash basis is simpler to record.

If your loss arises partly from asset purchases, you still get the loss relief. There is no restriction that says capital expenditure losses cannot be relieved.

When the Cash Basis Might Not Be Best for a Loss Year

There are situations where the accruals basis gives you better loss relief. If you have significant unpaid invoices at the year end, the accruals basis recognises that income in the current year. That could turn a loss into a profit, or reduce the loss, which might be beneficial if you want to use sideways relief against other income in a year when you have high earnings.

Conversely, if you have paid expenses in advance (prepayments), the cash basis deducts them immediately. The accruals basis spreads them over the period they relate to. If you prepaid £6,000 of business insurance for 12 months in March 2026, the cash basis deducts the full £6,000 in 2025/26. Accruals would only deduct £500 (one month). The cash basis gives you a larger loss now.

You can opt out of the cash basis if it does not suit your circumstances. You do that on your self assessment tax return by ticking the box to use accruals accounting instead. If your turnover is below the threshold, you can choose either method each year. You are not locked in.

Making Tax Digital for Income Tax Self Assessment (MTD for ITSA)

From April 2026, sole traders with qualifying income over £50,000 must use MTD-compatible software and submit quarterly updates to HMRC. The cash basis is fully compatible with MTD. If you are making a loss, you still submit the same quarterly updates showing your income and expenses. The loss is carried forward or claimed through your annual declaration.

From April 2027, the threshold drops to £30,000. From April 2028, it drops to £20,000. Most sole traders will be in MTD within three years. If you are already using the cash basis, your bookkeeping software like FreeAgent or Xero will handle the quarterly reporting automatically.

Losses under MTD work exactly the same way as on paper. The quarterly updates are cumulative, so your year-to-date loss shows clearly. When you submit your final declaration, you make your loss relief claim.

What to Put on Your Self Assessment Tax Return

When you complete your SA100 and SA103 (self-employment pages) for 2025/26, you enter your income and expenses as usual. The tax return calculates the profit or loss automatically. If the result is a loss, you enter that figure in the loss relief boxes.

On the SA103, there are specific boxes for:

  • Loss brought forward from earlier years (box 72)
  • Loss to carry forward to later years (box 73)
  • Loss claimed against other income for the same year (box 74)
  • Loss claimed against other income for the previous year (box 75)

You also need to complete the white space on the return or attach a separate computation explaining how the loss arose, especially if you are claiming sideways relief. HMRC may ask for evidence, so keep your records organised.

If you are claiming early trade loss relief, you complete form HS227 and submit it with your return. For terminal loss relief, use form HS227 as well.

Cash Basis Loss and Partnership Businesses

Partnerships can also use the cash basis, provided the partnership turnover is below the threshold. If a partnership makes a loss, each partner's share of the loss is calculated under the cash basis. Each partner then claims loss relief on their individual tax return.

The same rules apply. A partner in a small design partnership in Bristol's Harbourside can offset their share of the partnership loss against their other income, carry it forward, or use early trade loss relief if the partnership is new.

Partnerships using the cash basis must still prepare a partnership tax return (SA800) showing the loss allocation to each partner. The accounting method is declared on the partnership return.

Common Mistakes With Cash Basis Losses

Three mistakes come up regularly:

1. Assuming you cannot claim loss relief because you use the cash basis. You can. The loss relief rules are independent of the accounting method.

2. Forgetting to claim sideways relief within the time limit. You must claim within 12 months of the 31 January following the tax year. For 2025/26, that means by 31 January 2028. Miss the deadline and you lose the relief.

3. Not keeping records of unpaid invoices. Even on the cash basis, you need to know what is outstanding. If HMRC queries your loss, you need to show that the income genuinely was not received in the year. A schedule of unpaid invoices is your evidence.

If you are unsure whether the cash basis or accruals basis gives you better loss relief in a specific year, run the numbers both ways. The difference can be significant, especially if you have large timing differences between invoicing and payment.

For more detailed guidance on sole trader accounting methods, see our fundamentals section. If you need help preparing your self assessment return or claiming loss relief, get in touch with our team. We handle loss claims regularly for sole traders across every sector.

And if you are considering incorporating your business to access different loss relief options, our incorporation guide explains the trade-offs.