Cash basis or traditional accounting? Sole traders and landlords

With cash basis you only record income or expenses when you receive money or pay a bill. If a customer pays you in May, the income belongs to May, whenever you sent the invoice.

With traditional accounting, also called accruals accounting, you record income and expenses by the date you invoiced or were billed. If you send an invoice in March and the customer pays in April, the income belongs to March.

The main difference is timing: which tax year, and which quarterly update, a sale or a cost falls into. That timing can matter around 5 April, when one tax year ends and the next begins.

From 6 April 2024, cash basis became the default method of accounting. GOV.UK calls it the standard way to record your income and expenses if you are a sole trader or a partnership without corporate partners. For property income, cash basis is also the default.

Before the 2024 to 2025 tax year, sole traders could only use cash basis below a turnover limit of £150,000, and had to leave it above £300,000. Those limits no longer apply.

You can choose traditional accounting instead. If you do, you need to say on your Self Assessment tax return that you have used traditional accounting. Landlords who want to use traditional accounting tick the box on the return to opt out of the cash basis. You may need to keep more records and make some adjustments when you switch.

Most sole traders can use cash basis. GOV.UK lists the businesses that cannot. Limited companies, limited liability partnerships and partnerships with one or more corporate partners are excluded, and so are the following.

• Lloyd’s underwriters.
• Farming businesses with a current herd basis election.
• Farming or creative businesses with a fluctuating profit averaging claim.
• Businesses that have claimed business premises renovation allowance within the previous 7 years.
• Businesses that carry on a mineral extraction trade.
• Businesses that have ever claimed research and development allowance.

A fictional self-employed photographer invoices a client £2,000 on 20 March 2027 for a job done that month. The client pays on 20 April 2027. The tax year ends on 5 April, so the invoice and the payment fall in different tax years.

Under cash basis, the £2,000 is income for the 2027 to 2028 tax year, because that is when the money arrived. It appears in the first quarterly update of that year. Under traditional accounting, the £2,000 is income for the 2026 to 2027 tax year, because that is when it was invoiced.

On cash basis, you claim the cost of equipment you buy to keep and use in your business, such as a laptop or tools, as a normal allowable business expense. On traditional accounting, you claim equipment through capital allowances instead.

Cars have their own rule. If you buy a car for your business, you claim it through capital allowances on either method, unless you use simplified mileage for that car. You cannot use simplified mileage for a car you have already claimed capital allowances on, and once you use the flat rates for a vehicle you must keep using them.

For landlords, capital spending such as improvements, extensions or a higher-specification kitchen is not an allowable expense against rental income. Replacing a domestic item like for like can qualify for relief, but buying an item for the first time does not.

GOV.UK suggests traditional accounting may suit a business that is complex, for example one with high levels of stock, or one that needs to get finance, because lenders may want to see traditional accounts.

There is also a practical difference with unpaid invoices. You cannot claim bad debts if you use cash basis accounting. This matters less than it sounds, because an invoice that is never paid was never counted as income on cash basis in the first place.

For most sole traders who are paid soon after doing the work, cash basis is simpler. Your bank account and your records tell the same story, and there is nothing to adjust at the year end for timing.

Cash basis is also the default for property income. Rent counts when you receive it and costs count when you pay them. If a tenant pays April’s rent on 2 April, it belongs to the tax year that ends on 5 April, under cash basis.

Some rules work the same way on either method. Residential finance costs, such as mortgage interest, are not an expense for individual landlords on either basis. Since 6 April 2020, relief is a basic rate tax reduction, and the finance costs go on their own line in your records.

If you want to use traditional accounting for your property income, tick the opt-out box on your tax return. Conditions for using cash basis apply to landlords too, so check HMRC’s guidance on working out your rental income first.

Making Tax Digital for Income Tax works with either method. HMRC says you do not need to make any accounting or tax adjustments before sending a quarterly update. Each update covers the tax year to date and is a summary, not a tax return.

The adjustments come at the year end, before you submit your tax return. Year-end adjustments include prepayments and accruals. HMRC says that if you use cash basis, you do not make accruals or prepayments adjustments. If you use traditional accounting, this is where timing differences such as the March invoice are put right.

On traditional accounting you can record sales when you invoice them. Or you can record cash during the year and adjust the category totals at the year end, before you submit your tax return.

Tax rules can change and your circumstances matter. Use HMRC’s current guidance to confirm what applies to you.