Trading Loss Relief — How to Use a Loss to Cut Your Tax Bill (2026)

A Trading Loss Is Not Wasted Money

A trading loss arises when your allowable business expenses for the year exceed your business income. That happens for all sorts of legitimate reasons: a slow first year while you build a client base, a large capital spend on tools or a van (claimed as capital allowances), a bad-debt write-off, a quiet trade year, or simply a downturn. The loss itself is calculated in exactly the same way as a profit — same accounting rules, same allowable expenses — it just comes out negative.

The key point is that HMRC lets you offset that loss against tax you would otherwise pay. The art of loss relief is choosing which income to set it against and when, so that the loss saves tax at the highest possible rate. Make the wrong choice and you still get relief — just less of it.

The Main Options for a Sole Trader or Partnership

If you trade unincorporated, you generally have five routes for using a trading loss. You don't have to pick just one — you can often combine them, for example setting part of a loss against other income this year and carrying the rest forward.

1. Sideways relief against other income

You can set the trading loss against your other income of the same tax year and/or the previous tax year. "Other income" means things like employment earnings, pension income, rental profits or savings and dividend income. This is often called sideways relief, and it is the most powerful option if you have substantial other income — for example, you run a trade in the evenings but also have a PAYE day job. Setting a loss against that employment income can generate a Self Assessment refund of tax already deducted under PAYE.

You choose whether to claim against the current year, the prior year, or both. You cannot, however, dial the amount up or down to leave just your personal allowance untouched — the claim absorbs as much income as the loss allows, which is one reason timing the claim matters.

2. Carry the loss back — and the early-years rule

The standard sideways claim already lets you reach back one year. But there is a special rule for new businesses. A loss made in any of the first four tax years of trading can be carried back up to three years and set against your total income of those earlier years, taking the earliest year first. This is one of the most valuable and least-used reliefs available to a new sole trader who left a well-paid job to start a trade — the loss can reclaim tax paid during the employed years.

3. Carry the loss forward (the default)

If you make no other claim, an unused trading loss is automatically carried forward and set against the future profits of the same trade. It reduces the first available profits, then the next, until it is used up — there is no time limit on how long it can be carried forward, provided you keep trading. This is the safest default and often the right answer when you have no other income to relieve, but it's also the slowest, because you wait for future profit to benefit.

4. Terminal loss relief when the business ceases

When a trade stops, a loss made in the final 12 months of trading (the "terminal loss") can be carried back and set against the profits of the same trade for the three tax years before the year of cessation, latest year first. This rescues relief that would otherwise be lost when there are no future profits to carry it forward into. It's essential to claim this if you're winding a trade down at a loss.

5. Relief against capital gains

In some cases, where a trading loss can't be fully used against income, the unused part can be set against your capital gains of the same and/or previous year. You have to make the income claim first, but if income is exhausted, extending the relief to capital gains can save Capital Gains Tax. This is a useful but conditional route — it only helps if you actually have chargeable gains in the relevant years.

The Cap on Sideways and Carry-Back Income Relief

There is an important limit. Where a loss is set against other income (sideways relief, including the loss carried back against general income), the amount relieved in a tax year is capped at the greater of:

• £50,000, or
• 25% of your adjusted total income for that year.

So someone with £160,000 of adjusted total income could relieve up to £50,000 (because 25% of £160,000 is £40,000, and £50,000 is greater). Someone with £400,000 could relieve up to £100,000 (25% being the larger figure). The cap does not apply to losses set against profits of the same trade — so carrying a loss forward, or the part of a loss set against the same trade's own profits, is unrestricted. The cap is aimed at large losses being used to shelter unrelated income.

How Company Loss Relief Differs

If you trade through a limited company, the loss belongs to the company, not to you personally — so it can only reduce the company's Corporation Tax, never your personal Income Tax. The mechanics are different too:

• Carry back 12 months: a trading loss can be carried back against the company's total profits of the previous 12 months, generating a Corporation Tax refund.
• Carry forward: unused losses are carried forward and, under the post-2017 rules, can be set against the company's total profits in future periods (subject to the annual deductions allowance for large losses), not just future profits of the same trade.
• Group relief: if your company is part of a group, a loss in one company can be surrendered to a profitable group company in the same period.

The practical takeaway for a director: a company loss can't reduce the tax on your salary or dividends. If you operate through a company and expect early losses, it's worth getting advice on whether the structure still suits you, because a sole trader can use those losses against personal income far more flexibly.

Quick Reference: Trading Loss Relief Options (Unincorporated)

Worked Example: A £15,000 Loss Turned Into a Refund

Sam is an electrician who went self-employed in 2025/26. After buying a van and tools and having a slow first half-year, the trade made a £15,000 loss. Sam also worked part of the year as a PAYE employee for a contractor and earned £40,000 of employment income, on which tax was deducted under PAYE.

Sam makes a sideways relief claim, setting the £15,000 trading loss against the same year's employment income:

• Employment income: £40,000
• Less trading loss claimed: £15,000
• Revised taxable income: £25,000

The £15,000 of income that's now relieved sat in the basic-rate band (20%), so the loss claim cuts the tax bill by roughly £3,000 (£15,000 × 20%). Because PAYE had already collected tax on the full £40,000 through the year, that £3,000 comes back as a refund once the Self Assessment return is filed. The loss is well within the £50,000 / 25% cap, so no restriction applies. Had any of the relieved income fallen in the higher-rate (40%) band, the saving on that slice would have been larger — which is exactly why the choice of year matters.

How You Claim a Loss

For a sole trader or partner, loss relief is claimed on your Self Assessment tax return — specifically the self-employment (or partnership) pages, where you enter the loss and indicate how you want to use it. Carry-forward is automatic if you make no other election, but sideways, carry-back, early-years and capital-gains claims must be made actively. A carry-back claim that affects an earlier year is given effect against that earlier year's liability, but the claim itself goes on the return for the year the loss arose.

Keep clean records. The figures behind a loss are exactly what HMRC will look at if it queries the claim, so your bookkeeping for the loss-making year needs to be as tight as for a profitable one — arguably tighter.

Time Limits for Claims

Loss claims are not open-ended. A claim to set a loss sideways or to carry it back must generally be made within one year of the 31 January filing deadline for the tax year in which the loss arose. So for a 2025/26 loss, the filing deadline is 31 January 2027 and the loss claim deadline is 31 January 2028. Miss it and the sideways and carry-back options are gone — you're left with carry-forward against future profits of the same trade, which has no time limit but is far less flexible. Don't leave loss claims until the last minute.

The Commercial Basis Requirement

HMRC will not allow sideways loss relief against other income unless the trade is carried on commercially and with a view to making a profit. This is the "profit motive" test, and it exists to stop people using a perpetual hobby loss to shelter their salary year after year. If your trade has never made a profit, has no realistic prospect of one, or looks more like a pastime than a business, HMRC can deny the relief against other income.

For a genuine trade going through a tough year this is rarely a problem — a one-off bad year, or losses in the early build-up phase of a real business, are clearly commercial. But keep evidence: a business plan, marketing activity, pricing intended to turn a profit, and a credible path back to profitability all help demonstrate the commercial basis if asked.

Why Timing the Choice Matters

Because you can often choose the year against which a loss is relieved, you can steer the loss toward income that's taxed at the highest rate. Relieving income in the higher-rate band (40%) saves twice as much tax per pound as relieving income in the basic-rate band (20%), and relief that strays into the £100,000–£125,140 band — where the personal allowance is tapered — can produce an effective saving above 60%.

Equally, beware wasting relief: a sideways claim that drags your income below the personal allowance throws away the unused part of the loss at a 0% rate, because the claim can't be restricted to leave the allowance intact. Sometimes carrying part of the loss forward to a profitable year, or back to a higher-rate year, saves more tax overall. Run the numbers across the eligible years before you commit to a claim — this is one of the few areas where a quick comparison genuinely changes the refund you get.

A Note on the Cash Basis

Many small sole traders use the cash basis (taxing money in and out rather than invoiced amounts). The cash basis is simpler, but it restricts some loss reliefs: in particular, losses calculated under the cash basis generally cannot be used for sideways relief against other income or carried back — they can usually only be carried forward against future profits of the same trade. If you have significant other income you'd like to relieve a loss against, the choice between cash basis and traditional accruals accounting directly affects what reliefs are available, so weigh it up before you file.

The Bottom Line

A trading loss is a one-off chance to recover or reduce tax — but only if you claim the right relief in time. Sole traders with other income should look hard at sideways relief and, if they're newly trading, the early-years carry back. Anyone ceasing a trade should check terminal loss relief before it's lost. Directors need to remember a company loss can only help the company. And everyone should keep the £50,000 / 25% cap, the commercial-basis test, the claim time limits and the cash-basis restriction in view. Get the choice right and a loss-making year can still hand you a tax refund.