Prediction Market Taxes: Capital Gains, Gambling, or Something Else?

Last Updated on September 1, 2026 by Robert Green

Update Sept. 1, 2026: Ninth Circuit Deepens Split Over Sports Event Contracts

The regulatory battle over prediction markets intensified on Aug. 28, 2026. The U.S. Court of Appeals for the Ninth Circuit (covers nine Western states) ruled that the Commodity Exchange Act (CEA) likely does not preempt Nevada’s gambling regulations as applied to Kalshi’s sports event contracts. The court concluded that Kalshi’s sports event contracts were not “swaps” for purposes of the CEA preemption issue because they were sports bets. The decision allows Nevada to regulate these contracts under its gambling laws while the litigation continues.

The ruling conflicts with the Third Circuit’s April 2026 decision involving New Jersey, which concluded that Kalshi’s sports event contracts were swaps under the CEA and therefore subject to the CFTC’s exclusive federal jurisdiction. The conflicting decisions create a significant circuit split over state gambling regulation versus federal CFTC regulation, increasing the possibility that the issue could eventually reach the U.S. Supreme Court. Approximately 20 states are now involved in litigation over prediction markets, and related issues are pending in several other federal appeals courts.

Sports contracts represent a substantial majority of Kalshi’s activity. In May 2026, Kalshi General Counsel and Chief Regulatory Officer Rick Heaslip disputed reports that 90% of Kalshi’s volume was sports, saying: “The last I checked it was something like 70%.” He also noted that the percentage is cyclical and had been declining. Other analyses suggest the sports-related percentage can be higher when combination or parlay contracts are included.

The dominance of sports contracts helps explain why much of the state-versus-federal regulatory battle has centered on sports rather than prediction markets generally. The Ninth Circuit described sports betting as a traditional form of gambling, while Kalshi and the CFTC maintain that qualifying event contracts fall within the federal derivatives regulatory framework.

Tax impact: These regulatory decisions do not determine federal income-tax treatment. However, the Ninth Circuit decision and growing state challenges strengthen the argument that sports prediction contracts may be more gambling-like than financial derivatives. Contracts tied to commodities, economic indicators, financial markets, cryptocurrency, or other commercial risks may present a different profile and potentially support a different tax analysis.

The widening divide between state gambling regulation and federal derivatives regulation reinforces the central point of this article: prediction market contracts should not necessarily all be placed into a single tax category, and the IRS needs to provide specific guidance.

Original article:

Prediction markets like Kalshi and Polymarket are growing rapidly—but their tax and regulatory treatment remains unsettled. Recent litigation in New Jersey and enforcement actions in New York alleging that certain event contracts, such as sports, constitute gambling may further influence how these products are viewed, although they do not determine federal tax treatment. If activity is treated as gambling, taxpayers may face the “standard deduction trap”—many taxpayers experience this because gambling loss relief is often only available through itemized deductions; and beginning in 2026, §165(d) can cap wagering-related deductions through its expanded definition of “losses from wagering transactions,” potentially leaving net winners or even break-even traders with taxable income.

There is currently no IRS guidance specifically addressing event contracts, so practitioners must analogize to existing rules for gambling, capital assets, and derivatives. As a result, practitioners apply a range of reasonable, fact-dependent positions.

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How Prediction Market Contracts Differ by Category

Not all prediction market contracts feel the same in practice.

On platforms like Kalshi, contracts based on:

Sports
Culture
Elections
Politics
Public events

often resemble traditional wagering (gambling) activity, where outcomes are event-driven and not tied to financial markets.

By contrast, contracts based on:

Commodities
Economic indicators
Financial markets
Cryptocurrency

often resemble trading or investment activity, where pricing reflects market expectations and economic data.

This distinction does not determine tax treatment, but helps explain why different frameworks are applied.

The Four Main Tax Approaches

1) Gambling Treatment (§165(d))

Some taxpayers treat prediction market activity as gambling:

Losses limited to winnings
No carryforward of excess losses
Often claimed as itemized deductions (depending on taxpayer circumstances)

Starting in 2026, amended IRC §165(d) generally limits the deduction to 90% of wagering losses. It also caps deductions to wagering gains and expands “wagering losses” to include otherwise allowable deductions incurred in carrying on wagering transactions.

👉 This can create taxable income even when you break even economically

Whether a particular platform’s event contracts are “wagering transactions” for §165(d) purposes is itself a classification question.

For contracts linked to financial or economic indicators, it is not clear that gambling treatment is more correct than capital or property treatment; some taxpayers use gambling treatment as a risk-averse compliance approach because it avoids claiming capital-asset benefits in an unresolved area.

See the loss example below for how these limitations can produce taxable income despite no economic profit.

2) Capital Gains Treatment (§1221)

Another approach treats contracts as capital assets under the default rule of §1221.

Why capital treatment is plausible under the current law:

Default rule: Property held by a taxpayer is a capital asset unless it falls within specific exclusions (e.g., inventory, accounts receivable, dealer property). Prediction contracts generally do not fit those exclusions.
Transferable property rights: Contracts are assignable/transferable claims with a cost basis and disposition price—hallmarks of capital assets.

Example: A trader buys a contract for $0.40 predicting that CPI will exceed a threshold. Before settlement, the market price rises to $0.70 as expectations change. The trader sells the contract to another participant for $0.70, realizing a $0.30 gain. This ability to buy, hold, and sell the contract to another party before settlement reflects a transferable property right, similar to other tradable financial positions.
Investment/speculation motive: Positions are typically entered to profit from price changes/probabilities, consistent with investment activity rather than ordinary-course business receipts.
Realization events: Gain or loss is realized upon sale, exchange, or settlement (binary payoff), aligning with capital realization principles.
Secondary trading: Many platforms allow entry/exit before settlement, reinforcing the treatment of the asset as tradable property rather than a one-off wager.
No clear ordinary regime: Absent a governing ordinary‑income regime (e.g., §475 or NPC rules), the analysis typically defaults to §1221 (capital asset) or, in some fact patterns, §165(d) (gambling).

Counterpoint: the IRS could argue certain contracts are sufficiently wager-like (especially sports or lifestyle contracts) to fall under §165(d), even if they are transferable.

Among practitioners focused on this area, capital-asset treatment appears to be a commonly used approach for regulated platforms among practitioners who favor capital-asset analysis, although the classification is not settled and may evolve.

What this allows:

Capital loss carryforwards (subject to the $3,000 annual limitation against ordinary income)
Netting of capital gains and losses across positions and years

Capital gains treatment is not an election—it depends on classification under §1221.

3) Ordinary Income (Non-Gambling)

Plain-English idea: Report gains for tax purposes as ordinary income (like wages/interest), not capital gains or gambling.

When people consider it:

As a practical reporting approach (e.g., Schedule 1 “other income”)
By analogy to derivatives (swaps), even though the fit is unclear

Why it’s hard to support as a true “derivatives” position:

No clear rule puts these contracts into an ordinary-income regime (e.g., §475 or NPC rules; §1256 is a capital 60/40 regime, not ordinary income)
Key derivative features are missing (no notional principal, no periodic payments, no statutory mark-to-market)

Important distinction in practice:

Some preparers report results as “other income” without claiming the contracts are tax derivatives.
That is different from asserting the instruments are ordinary-income derivatives under §§446 or 475.

Bottom line: Ordinary treatment is used in some cases for simplicity, but there’s no clear authority requiring it, and a full derivatives-style position is harder to justify.

Recent case-law and enforcement developments:

Recent developments show differing characterizations across jurisdictions and contract types:

New Jersey litigation: Certain event contracts—particularly those tied to sports and similar outcomes—have been analyzed under state gambling frameworks. These cases tend to focus on sports-type contracts, reinforcing their similarity to wagering/gambling, but the rulings are fact-specific and limited to that jurisdiction.
Federal regulatory (Third Circuit / CEA): Courts have recently concluded that some Kalshi contracts fall within the Commodity Exchange Act and CFTC jurisdiction. This analysis often centers on whether contracts resemble derivatives, but it does not distinguish tax treatment.
New York Attorney General (April 2026): Actions against Coinbase and Gemini allege certain prediction market products—again largely tied to sports and election outcomes—constitute illegal gambling under state law.

Taken together, recent regulatory and enforcement activity has focused primarily on sports and event-based contracts, which more closely resemble gambling. By contrast, contracts tied to financial markets, economic indicators, or commodities may present a different profile, potentially supporting non-gambling characterizations depending on the facts.

These are state-law and regulatory classifications, not federal tax determinations. State gambling characterizations are often driven by consumer-protection and licensing concerns and may not align neatly with federal income-tax categories.

State gambling determinations and CEA classifications do not control treatment under the Internal Revenue Code.

To date, there is no published federal tax authority concluding that these contracts are notional principal contracts, gambling per se, or otherwise produce ordinary income.

In addition:

Contracts are typically transferable and held for investment/speculation, characteristics of capital assets under §1221
There is no IRS guidance treating these contracts as ordinary income instruments

As a result, ordinary income treatment is fact-specific and less commonly used, and may be subject to challenge without clear authority.

The IRS has historically been cautious about positions that allow taxpayers to generate or accelerate ordinary losses outside clearly defined frameworks. In this context, capital loss treatment—with its $3,000 limitation and carryforward rules—aligns more closely with existing structures than broad ordinary loss treatment. Again, sports and similar lifestyle contracts might be gambling.

4) §1256 (60/40 Treatment) and Its Limits

§1256 offers favorable tax treatment:

60% long-term / 40% short-term capital gains
Lower effective tax rates
Loss carrybacks up to three years (against §1256 gains)

Example:
A $100,000 §1256 gain yields a blended federal rate of ~26.8% vs. 37% ordinary—saving about $10,200 at the highest marginal rate.

Requirements:

Traded on a qualified board or exchange (QBE)
AND meets the statutory definition of a §1256 contract (e.g., regulated futures contract, non-equity option)

A Designated Contract Market (DCM) may qualify as a QBE, but exchange status alone is not sufficient—the contract itself must still meet the §1256 definition.

Why prediction markets likely do not qualify:

Not clearly “regulated futures contracts” as defined in §1256
No established statutory mark-to-market framework for these contracts
Event-based outcomes vs. traditional financial underlyings
Not clearly within the statutory categories of “section 1256 contract” (e.g., regulated futures contract or listed nonequity option)

Swap considerations:

Even if contracts are CFTC-regulated, that does not automatically make them “regulated futures contracts” for §1256 purposes.

Some event contracts have been described as “swaps” under the Commodity Exchange Act. However:

Regulatory classification does not control tax treatment

It is possible that CFTC classification as a derivative or swap could influence how tax authorities analyze these instruments over time, particularly if the IRS seeks to align tax treatment with regulatory frameworks. However, current law does not automatically import Commodity Exchange Act definitions into the Internal Revenue Code, and key features of traditional tax derivatives (e.g., notional principal, periodic payments, or statutory mark-to-market regimes) are not clearly present in most prediction contracts.

§1256 excludes certain swap-type instruments
Contracts do not clearly fit NPC rules

👉 §1256 treatment is uncertain and may be considered aggressive

Attempts to claim §1256 treatment for prediction market contracts have attracted interest, but there is currently no clear authority supporting this approach.

Key Issue: Loss Treatment

Practitioner Insight: Capital vs. Gambling Losses

Capital treatment (§1221): Losses are preserved via carryforwards (subject to the $3,000 annual limit against ordinary income) and can offset future capital gains—supporting long-term tax efficiency.

Gambling treatment (§165(d), OBBBA 2026): Losses are limited to winnings, with only 90% of otherwise allowable losses deductible; excess losses are not carried forward.

Standard deduction trap: For many taxpayers, gambling losses are claimed as itemized deductions; those who claim the standard deduction may receive little or no benefit from losses, increasing the risk of tax on net-zero or losing activity.

Practical impact: For active traders, the ability to carry losses forward is often more important than marginal tax rates.

Risk lens: Positions that push toward ordinary loss treatment offer potential benefits but carry higher uncertainty under current law.

The most important difference between approaches is loss utilization.

Capital Loss Example

Assume a $50,000 capital loss in 2025:

$3,000 deductible in 2025
$47,000 carried forward

In 2026, with a $60,000 capital gain:

Net taxable capital gain = $13,000

Capital losses are preserved and carried forward indefinitely.

IRC §1091, by its terms, applies to “stock or securities” (and certain contracts/options on them), so many taxpayers take the position that wash-sale rules do not apply to prediction contracts treated as non-securities property; however, this is fact-dependent, not addressed by specific IRS guidance, and taxpayers should be cautious about recycling short-term losses in economically similar positions.

Gambling Loss Example (2026 OBBBA)

Assume only this gambling activity for the year:

Winnings: $100,000
Losses: $100,000

Under OBBBA:

Deductible losses = $90,000
Taxable income = $10,000

Tax is owed even with no economic profit.

With the standard deduction trap, losses might be further underutilized.

If losses exceed winnings:

Excess losses are not deductible or carried forward

Trader Tax Status (TTS) and §475

Trader Tax Status (TTS): Trader Tax Status requires substantial volume, frequency, continuity, and regularity with an intent to operate a trading business. It is uncertain whether prediction market activity alone meets these standards, and if the activity is characterized as gambling, it generally would not qualify for TTS.

Professional gambler status: A taxpayer may report gambling activity as a trade or business (Schedule C). To qualify, the activity must be conducted with regularity, continuity, and a profit motive, rising to the level of a trade or business rather than sporadic wagering. This allows ordinary and necessary business expenses (other than losses) to be deducted above the line. However, losses remain limited under §165(d)—including the OBBBA change for 2026 and later—so losses are deductible only to the extent of winnings and only 90% of otherwise allowable losses are permitted. In practice, this can limit the benefit of both losses and related expenses.

§475 (mark-to-market): §475 applies only to securities and certain commodities for taxpayers who qualify and elect it on time (i.e., a trader in securities or commodities who makes a valid election under §475(f)). Prediction market contracts are not clearly securities or commodities for §475 purposes. In practice, many taxpayers active in prediction markets also trade securities or futures, and any §475 election would generally apply to those qualifying activities—not standalone event contracts.

Platform and Reporting Considerations

Prediction markets operate across different structures:

CFTC-regulated platforms (e.g., Kalshi)
Offshore or decentralized platforms
Emerging U.S. regulated offerings

These differences may influence perception, but do not determine tax classification.

In addition:

Platforms may not provide full Form 1099-B
Even when information returns are provided, they may not reflect your chosen tax treatment or complete cost basis
Taxpayers often must track and report transactions manually
Some platforms and third-party articles assert that prediction-market income is “ordinary income”; as of 2026, the IRS has not issued formal guidance adopting that view.

State Tax Disclaimer

State tax treatment of prediction market activity may differ significantly from federal rules. Some states may not conform to federal gambling loss limitations, may restrict loss offsets, or classify these contracts differently. State-specific rules, residency, and nexus can materially affect tax outcomes. Taxpayers should consult a qualified advisor regarding state and local implications.

Bottom Line

Prediction market taxation remains a gray area:

Capital gains → commonly used
Gambling → commonly viewed as conservative but increasingly punitive
§1256 and other approaches → uncertain

There is no definitive rule; classification depends on the facts. Once a taxpayer adopts a reasonable, fact‑based position, it is important to apply it consistently and document the rationale.

This article does not recommend a specific tax position, but outlines approaches currently used in practice.

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Hopefully, the IRS will provide tax guidance on prediction market contracts soon.

Some CPAs may be cautious about offering tax compliance services in this area until the IRS issues guidance, while others proceed using documented, fact-specific frameworks like those described above.