Are Prediction Markets Taxed as Gambling?

Does the gambling fight in court change how you're taxed?

On the regulatory question, the courts are split. The federal record treats these as financial contracts, and the fight over whether state gambling law can reach them anyway is in the courts now.

Kalshi and Polymarket US operate as designated contract markets regulated by the Commodity Futures Trading Commission, not as state-licensed sportsbooks. Two consequences are visible to any trader:

• You can trade sports event contracts in Texas and California. Sports betting is illegal in both. That is roughly 70 million people between them, and they are two of the ten states with no legal sports betting at all. The contracts are available anyway because federal commodities regulation is asserted to preempt state gambling law.
• Kalshi's minimum age is 18. Most states set sportsbooks at 21. A CFTC-regulated derivatives exchange follows the general age of majority, because it is regulated as a financial venue rather than a gambling one.

In April 2026 the U.S. Court of Appeals for the Third Circuit addressed this directly. In a 2-1 decision (KalshiEX, LLC v. Flaherty, No. 25-1922), the court affirmed a preliminary injunction barring New Jersey from enforcing its gambling laws against Kalshi, holding that Kalshi was likely to succeed in showing that sports event contracts are "swaps" under the Commodity Exchange Act and that the CEA preempts state gambling law as applied to them. Judge Roth dissented, writing that the contracts are virtually indistinguishable from bets offered by state-regulated sportsbooks.

Two honest caveats on that ruling. It affirmed a preliminary injunction, a likelihood-of-success standard, not a final merits judgment. And it is a regulatory holding, not a tax one; it says nothing about §165(d), §1256, or how you file.

In August 2026 the Ninth Circuit went the other way, and courts have now split on it: see is Kalshi gambling?, and where Kalshi is legal today.

Does that settle how they are taxed?

No. Regulatory characterization and tax characterization are different questions decided by different bodies, and the IRS has answered neither.

The regulatory record is what each side of the tax argument cites. IRC §165(d) limits deductions for "losses from wagering transactions." Whether a contract traded on a CFTC-designated exchange is a wagering transaction is the open question, and no ruling has resolved it.

Note the direction the swap argument cuts. A swap is a financial instrument, which is an argument against wagering treatment. It is also an argument against §1256, for the reasons below. The two points are not in tension; they simply push toward the middle of the spectrum.

What would gambling treatment actually cost you?

Two rules set what it reports for a year.

The 90% cap. For tax years beginning after December 31, 2025, §165(d) as amended by the One Big Beautiful Bill Act allows a deduction equal to 90% of wagering losses, still only to the extent of wagering gains. The disallowed 10% is taxed as income you never kept.

Work it through on a break-even year. Say you trade daily, win $100 on your winning days and lose $100 on your losing days, and finish exactly flat: $36,500 of winnings against $36,500 of losses.

The itemizing requirement. Per IRS Topic No. 419, "you may deduct gambling losses only if you itemize your deductions on Schedule A." Most filers take the standard deduction. For that trader, the deduction for those losses is zero, and the same break-even year is taxed on the full $36,500.

Our guide on the OBBBA 90% gambling-loss limit covers that rule and its repeal prospects in detail.

How do the two trading treatments compare?

Ordinary capital treatment. Gains and losses are capital. Anything held under a year is short-term and taxed at ordinary rates, which covers nearly every prediction-market position. Losses net against capital gains in full. Under §1211(b), net losses beyond that deduct up to $3,000 per year against ordinary income ($1,500 if married filing separately). At a 22% federal rate, that $3,000 is roughly $660. What remains carries forward under §1212(b); the IRS states no expiration for the carryover, so unused losses keep offsetting future gains and income until they are used up.

Section 1256 treatment. Under §1256, gains and losses are treated as 60% long-term and 40% short-term regardless of holding period, with mark-to-market at year end, reported on Form 6781. A net §1256 loss can also be carried back three years against prior-year net §1256 gains under §1212(c), though it cannot create or increase a net operating loss. 60% of a gain is taxed at long-term rates however briefly the position was held, and a net loss can be carried back, which a carryforward alone does not offer. See our Section 1256 60/40 guide for the mechanics.

No court or IRS ruling has applied it to event contracts, and the arguments run both ways:

• For: these exchanges are CFTC-designated contract markets, which satisfies the "qualified board or exchange" prong at §1256(g)(7)(B): a domestic board of trade designated as a contract market by the CFTC. A binary contract with a fixed payout can be read as a nonequity option.
• Against: §1256(b)(2)(B) excludes swaps and "similar agreements" from the definition, and event contracts are swaps under the Commodity Exchange Act, the characterization the Third Circuit reinforced in April 2026. On top of that, the IRS has never ruled that event contracts qualify, and mark-to-market cuts both ways: it can accelerate tax on open winners you have not sold.

The three treatments side by side

What each treatment costs and what each one depends on are different questions, so the table keeps them apart.

Note: the §1256 row assumes prediction-market event contracts qualify as §1256 contracts, which is not settled. Realize prices all three for the same year, since none of them is settled. The comparison of prediction market tax software lays out the common approaches.

Does paying more tax make a return more correct?

Plenty of traders reason this way: this feels like gambling, so I will file it as gambling, pay more, and stay out of trouble.

Paying more tax is not the same as filing correctly. Which characterization is correct depends on what the instrument is, not on how much tax it produces or how the activity feels. These contracts are bought and sold on a CFTC-designated exchange, at a price that moves; whether that makes them wagers is the open question.

Gambling treatment works on gross winnings and losses; capital treatment nets them. The regulatory record that bears on the question is the one above: CFTC designation of the venues, and a Third Circuit holding that sports event contracts are likely swaps, which the Ninth Circuit did not follow for Nevada. The IRS has not ruled on it either way.

Run your own numbers

The spread between these treatments depends on how much you traded, not just how you finished. Because §165(d) works on gross winnings and losses while capital treatment nets, a high-churn break-even year and a low-churn break-even year look identical on a P&L and completely different on a return.

Our free prediction market tax calculator prices all three treatments for a year of trading, with no sign-up and no email. The itemize toggle is the one worth playing with, since it is the difference between a partial deduction and none at all. The figures are estimates under stated assumptions, not a filed return.

What is genuinely unsettled

To be explicit about the limits of everything above:

• There is no IRS guidance on event contracts. No ruling, no notice, no regulation. Whether they are §1256 contracts is a real open question, and whether they are wagering under §165(d) is technically open too, with designated-contract-market status the main argument cited against it.
• Guidance may not be prospective only. If the IRS issues guidance, it could apply to open prior years, whichever treatment those returns used.
• The state fight is live and moving. Bans, taxes, and preemption litigation are all in progress. That affects where you can trade, not how you file federally.
• This is federal only. State tax treatment varies and is not covered here.

For the bigger picture, start at the Prediction Market Tax Center, and see our related guides on whether Kalshi winnings are taxable and what to track for taxes.

The bottom line

No IRS guidance characterizes prediction-market contracts as gambling. The current regulatory record (CFTC-designated exchanges, a federal appeals court holding these are likely swaps, and availability in states where sports betting is illegal) is what each side of the tax argument cites; the Ninth Circuit went the other way for Nevada. The tax question is separate from the regulatory one and remains genuinely open. Each treatment's cost follows from its mechanism: §165(d) works on gross winnings with a 90% loss cap, capital treatment nets gains and losses, and §1256 taxes 60% of a gain at long-term rates whatever the holding period. Complete records of every trade are what each of the three is computed from.

Status as of September 23, 2026. The litigation and legislation described here are active and may change; verify the current position before relying on it.

Questions people ask

Are prediction markets taxed as gambling?

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There is no IRS ruling, notice, or regulation characterizing prediction-market event contracts as wagering under §165(d). On the regulatory side, Kalshi and Polymarket US are CFTC-designated contract markets, and in April 2026 the Third Circuit held that sports event contracts are likely "swaps" under the Commodity Exchange Act, subject to exclusive CFTC jurisdiction. In August 2026 the Ninth Circuit reached the opposite view for Nevada, so the circuits are split. Those were jurisdictional rulings, not tax rulings. How these contracts are taxed remains an open question.

What does gambling tax treatment cost a prediction-market trader?

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Two rules set the result. First, for tax years beginning after December 31, 2025, IRC §165(d) allows a deduction equal to 90% of wagering losses, still capped at your wagering gains, so a break-even year produces taxable phantom income equal to 10% of your losses. Second, wagering losses are an itemized deduction on Schedule A: if you take the standard deduction, as most filers do, the deduction is zero and the full winnings figure is taxed.

Does paying more tax under gambling treatment make a return more correct?

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No. Which characterization is correct depends on what the instrument is, not on how much tax it produces. The cost of each treatment depends on the mechanics of the rule, and none of the three is settled for event contracts: the IRS has issued no guidance.

Does Section 1256 apply to Kalshi and Polymarket contracts?

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This is unsettled. The argument for it: both are CFTC-designated contract markets, which satisfies the "qualified board or exchange" prong at §1256(g)(7)(B). The argument against it: §1256(b)(2)(B) excludes swaps and similar agreements, and event contracts are swaps under the Commodity Exchange Act, a characterization the Third Circuit reinforced in April 2026. The IRS has never ruled that event contracts qualify. On a gain, Section 1256 taxes 60% at long-term rates regardless of holding period, and no court or IRS ruling has applied it to event contracts.

Do state court orders against prediction markets change how I file federally?

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No. Those cases decide who regulates these markets and where they can operate, not how the IRS characterizes your gains and losses, and a state court finding that a contract is likely gambling under state law is not a tax ruling. For where each case stands, see our guide "Is Kalshi legal in my state?". This guide covers federal treatment only; state tax treatment varies and is out of scope.