4 Ways the IRS Might Tax Your Prediction Market Trades

Prediction markets are a new asset class. The IRS has published guidance for stocks, bonds, real estate, crypto, and even NFTs — but not for event contracts or binary prediction markets.

This regulatory gap means traders and their tax professionals have to fit prediction market profits into an existing tax category. There are four reasonable options, each with legal precedent from analogous financial instruments:

• Ordinary income — like freelance income or miscellaneous earnings
• Capital gains — like stock or crypto trading
• Section 1256 contracts — like regulated futures
• Gambling income — like sports betting or poker

The "right" answer depends on your platform, trading activity, and risk tolerance. Let's break down each one.

How it works: Report your net P&L (total profits minus total losses) as "Other Income" on Schedule 1, Line 8z of your Form 1040.

Tax rate: Your marginal income tax rate (10% to 37%, depending on your bracket).

Pros:

• Simplest method — one number on one line
• Losses reduce your taxable income dollar-for-dollar
• No per-position tracking required

Cons:

• Taxed at your full marginal rate (no preferential treatment)
• May trigger self-employment tax if the IRS considers it business income (unlikely for casual traders)

Example: You made $8,000 and lost $3,000 across all prediction markets. Report $5,000 on Schedule 1, Line 8z. If you're in the 24% bracket, you owe $1,200.

Best for: Casual traders with small amounts who want the simplest filing method.

How it works: Treat each prediction market position as a capital asset. When a market settles or you sell your shares, it's a taxable disposition. Report each one on Form 8949 and summarize on Schedule D.

Tax rate: Short-term gains (held ≤ 1 year) are taxed at ordinary rates. Long-term gains (held > 1 year) are taxed at 0%, 15%, or 20%.

Pros:

• Most widely accepted treatment for financial assets
• Deduct up to $3,000 in net capital losses per year against other income
• Unused losses carry forward to future years
• Position-level tracking provides clear audit trail

Cons:

• Requires per-position record-keeping (every buy, sell, settlement)
• Most prediction market trades are short-term, so no long-term rate benefit
• More forms to file (Form 8949 can be many pages)

Example: You had 47 prediction market positions in 2025. Each one goes on Form 8949 with date acquired, date sold/settled, cost basis, and proceeds. Your net gain is $5,000 short-term. In the 24% bracket, you owe $1,200.

Best for: Active traders who want loss deductions and clean record-keeping. The recommended approach for Polymarket and Robinhood.

How it works: Report your net gain or loss on Form 6781. The IRS automatically splits it: 60% is taxed as long-term capital gains and 40% as short-term, regardless of how long you held the position.

Tax rate: Blended rate. For someone in the 32% bracket: (60% × 20%) + (40% × 32%) = 24.8% instead of 32%.

Pros:

• Lowest effective tax rate for short-term traders
• 60% of gains taxed at the lower long-term rate even if held for one day
• Simpler than Form 8949 — report net amount on Form 6781
• Losses can be carried back 3 years (unique to 1256 contracts)

Cons:

• Only defensible for CFTC-regulated platforms (primarily Kalshi)
• The IRS hasn't explicitly confirmed event contracts qualify
• Moderate audit risk — you need to be prepared to defend this position

Example: $5,000 net gain on Kalshi. Section 1256 splits it: $3,000 long-term (20% = $600) and $2,000 short-term (32% = $640). Total tax: $1,240 vs $1,600 at ordinary rates. You save $360.

Best for: Kalshi traders in higher tax brackets. The savings scale with income and profit size.

How it works: Report gross winnings (not net) as "Other Income" on Schedule 1. Losses are deductible only if you itemize on Schedule A, and only up to the amount of your winnings.

Tax rate: Your marginal rate applies to gross winnings. Starting in 2026, OBBBA caps loss deductions at 90% of winnings.

Pros:

• Legally defensible — prediction markets share characteristics with gambling
• Professional gamblers can deduct business expenses

Cons:

• Reports gross winnings, not net — you can't simply net out losses
• Losses only deductible if you itemize (most people take the standard deduction)
• Starting 2026, OBBBA caps loss deductions at 90% of winnings
• Typically the most expensive method for most traders

Example: You won $8,000 and lost $3,000. Under gambling treatment, you report $8,000 in income. If you itemize, you deduct $3,000 on Schedule A. Net taxable: $5,000. But if you don't itemize, you owe tax on the full $8,000. In the 24% bracket, that's $1,920 instead of $1,200.

Best for: Generally not recommended unless you're already itemizing and have significant other gambling losses to offset.

Here's how all 4 methods compare for a trader in the 32% bracket with $10,000 in gross winnings and $4,000 in losses ($6,000 net profit):

Method	Taxable Amount	Effective Rate	Tax Owed	Risk Level
Section 1256	$6,000 (60/40)	~24.8%	$1,488	Moderate
Capital Gains	$6,000 (ST)	32%	$1,920	Conservative
Ordinary Income	$6,000	32%	$1,920	Conservative
Gambling (itemizing)	$10,000 − $4,000	32%	$1,920	Conservative
Gambling (standard ded.)	$10,000	32%	$3,200	Conservative

The difference between Section 1256 and gambling (standard deduction) is $1,712. Even between Section 1256 and capital gains, the savings are $432 on just $6,000 in profits.

Use this decision framework:

1. Do you only trade on Kalshi? → Consider Section 1256. Kalshi's CFTC regulation makes this the most defensible and typically cheapest option.
2. Do you trade on Polymarket or Robinhood? → Capital Gains is the safest choice. You get loss deductions without the audit risk of Section 1256 on non-CFTC platforms.
3. Do you have a small amount of profits and want simplicity? → Ordinary Income. One line on Schedule 1. Easy.
4. Do you already itemize deductions? → Gambling income is defensible but rarely the cheapest option. Avoid if you take the standard deduction.
5. Do you trade on multiple platforms? → You can use different methods for different types of contracts. Section 1256 for Kalshi (if CFTC-regulated) and capital gains for everything else.

The best approach: calculate all four. Import your trades, see the exact dollar amount for each method, and then decide. That's exactly what our calculator does — for free.

Generally, yes. There's no IRS requirement to use the same prediction market tax treatment every year. However:

• You must be consistent within a single tax year. Don't report some Kalshi trades as capital gains and others as gambling income in the same year.
• If you elected Section 1256 in a prior year, you can switch to capital gains this year without permission.
• Keep records of which method you used each year. If audited, the IRS will look for consistency and documentation.
• If you're unsure, consult a CPA who understands financial instruments. The cost of a one-hour consultation ($150–$300) is far less than the potential tax savings.

Bottom line: The IRS hasn't drawn clear lines here. Use the method that's most defensible for your situation, apply it consistently, and keep good records. And always run the numbers first.