Cash Basis Accounting for Sole Traders and Landlords 2026/27

Cash basis accounting was designed to make tax simpler for small businesses. Instead of the traditional accruals approach -- where income is recognised when billed and expenses when incurred -- cash basis works on actual money movements. Income counts when it hits your bank account; expenses count when you pay them. From 2024, the government made cash basis the automatic default for property businesses, reflecting its growing mainstream status. But cash basis is not always the most tax-efficient choice, and the restrictions on loss relief and interest deductions can catch out businesses that would be better served by the traditional method.

The difference between cash basis and accruals

The accruals basis (also called the traditional or GAAP basis) matches income to the period in which it was earned and expenses to the period in which they were incurred. A plumber who completes a job in March 2026 and invoices the client, but receives payment in May 2026, includes the income in 2025/26 (when the job was done) under accruals. Under cash basis, the same income is included in 2026/27 (when the payment is received).

This timing difference has practical implications:

• Businesses with debtors (money owed to them) will have lower taxable income under cash basis in the short term because unbilled or outstanding invoices do not count until cash is received.
• Businesses with outstanding supplier invoices (creditors) will also have differences because unpaid bills are not deducted under cash basis until they are paid.
• At the end of the business, any outstanding balances must be accounted for -- you cannot simply leave a debtor unpaid and ignore the income permanently.

Self-employed cash basis: who can use it and how

For sole traders and unincorporated partnerships:

Entry condition: Annual trading turnover must not exceed £150,000 in the tax year.

Exit condition: You must leave cash basis if annual trading turnover exceeds £300,000. The exit is mandatory and takes effect from the start of the next tax year.

Elections: You do not need to notify HMRC that you are using cash basis -- you simply prepare your accounts on that basis and tick the relevant box on the self-employment pages of your self-assessment return (SA103). If you wish to use the accruals basis instead (perhaps because you want full loss relief or capital allowances), you can do so without restriction.

Property businesses: cash basis as default from 2024

A significant change took effect from the 2024/25 tax year: cash basis became the default method for unincorporated property businesses. This covers:

• Individuals letting residential property.
• Individuals letting commercial property.
• Partnerships of individuals with property income.

Landlords who previously used accruals are automatically on cash basis from 2024/25 unless they actively elect out. The election to use accruals must be made on the self-assessment return.

Why might a landlord want to elect out of cash basis?

• To use the full range of loss relief options (cash basis restricts property losses to carry-forward only).
• To account for rent in arrears on a more tax-efficient basis.
• To deduct accrued expenses (such as professional fees outstanding at year end) earlier.

Capital expenditure under cash basis: no capital allowances

One of the most significant differences between cash basis and accruals is how capital expenditure (spending on assets rather than expenses) is treated.

Under the accruals basis, capital expenditure goes through the capital allowances system:

• Annual Investment Allowance provides 100% first-year relief on qualifying plant and machinery.
• Writing-down allowances apply to any expenditure above the AIA limit.

Under cash basis, there is no separate capital allowances calculation. Instead:

• Capital expenditure is simply deducted in full in the year of payment.
• No distinction is made between revenue expenses and capital expenditure for most purposes.
• However, cars are still treated separately: only the business-use proportion of a car's running costs is deductible. Capital cost of the car is not deductible; instead, use HMRC's simplified mileage rates (45p per mile for the first 10,000 business miles, 25p thereafter) as an alternative.

For most small businesses with limited capital expenditure, this simplification is welcome. For businesses that might otherwise want to use sophisticated capital allowance planning (such as a business with integral building features), accruals with the AIA structure may be more beneficial.

The £500 interest deduction cap

Under cash basis for trading businesses, the deduction for loan interest paid is capped at £500 per year. This applies to:

• Interest on bank loans or overdrafts used for business purposes.
• Interest on other financing arrangements.

This cap does not apply to property businesses using cash basis -- which have their own interest restriction under Section 24 (the 20% tax credit for mortgage interest).

For a sole trader with a significant business loan, the £500 cap on interest deductions is a major disadvantage compared to the accruals basis (where the full interest amount is deductible as a business expense). Any business with annual interest costs significantly above £500 should consider whether accruals is more appropriate.

Loss relief: the cash basis restriction

Under the accruals basis, self-employment losses can be offset against:

• Other income in the same tax year.
• Other income in the prior tax year (carry-back).
• Future profits from the same trade (carry-forward).
• In the first 4 years of a new business, losses can be carried back 3 years.

Under cash basis, loss relief is significantly restricted. Cash basis losses can only be:

• Carried forward against future profits from the same trade.

They cannot be:

• Offset against other income in the same year.
• Carried back to prior years.

For a business with a loss year followed by other taxable income (salary, property income, etc.), cash basis means the loss cannot be used to reduce that other tax. Only when the trade generates future profits can the loss be utilised. This restriction is a compelling reason to consider the accruals basis for businesses in their early loss-making years.

Exiting cash basis: the adjustment rules

When a business leaves cash basis -- either voluntarily or because turnover exceeds £300,000 -- adjustments are required to prevent income being taxed twice or expenses deducted twice.

HMRC provides a transition formula:

• Add to income: Any amounts included in accruals-basis income that have not yet been received in cash (i.e., outstanding debtors at the transition date).
• Deduct from income: Any amounts that were received in cash during the cash basis period but would not yet be income under accruals (e.g., advance payments relating to future periods).
• Add to expenses: Amounts owed to suppliers at the transition date that have not yet been paid.
• Deduct from expenses: Prepayments made during the cash basis period.

The net adjustment is included as income or a deduction in the first accruals-basis tax year. If the adjustment creates a large income spike, it can be spread over a 6-year period in some circumstances.