Increased erosion associated with land use change often alters the flux of sediments and nutrients, but few studies have looked at the interaction between these disrupted cycles. We studied the effects of gully erosion on carbon and nitrogen storage in surface soil/sediment and herbaceous vegetation and on C and N mineralization in a headwater catchment used for cattle grazing. We found significantly lower C and N stored in an incising gully compared with an intact valley. This storage was significantly higher in an adjacent stabilizing gully, although not to the levels found in the intact valley. The intact valley had two to four times higher soil/sediment concentrations of total organic C, total N and Colwell extractable P than the incising gully. Lower storage was not explained by differences in vegetation biomass density or silt and clay content. Vegetation accounted for only 8% of C and 2% of N storage. Although not a significant store in itself, vegetation has an important indirect role in restoring and maintaining soil/sediment C and N stocks in eroding areas. We found significant linear relationships between C and N mineralization rates and soil/sediment C and N content, with lower rates occurring in the eroded sediment. These findings support our initial hypothesis that gully erosion reduces C and N storage and mineralization rates in eroding catchments. The implications of this study include a change to the quality of eroded sediments in headwater catchments, causing C-poorer and N-poorer sediments to be exported but overall loads to increase.