Prediction-market event contracts raise unresolved federal income tax questions because they combine features of wagers and financial instruments. A typical contract may allow a participant to buy a “yes” or “no” position on whether a specified event will occur—such as the outcome of a sports contest, election, weather event or other real-world contingency. Economically, these contracts can resemble wagers because the payoff depends on an uncertain event. At the same time, many are traded on regulated platforms and may resemble options, futures, swaps, or other financial contracts.
The IRS has not issued guidance specifically addressing the federal income tax treatment of prediction-market contracts. As a result, the proper treatment should be analyzed contract by contract. The most relevant tax frameworks are as follows:
Because no single rule clearly governs all prediction-market contracts, taxpayers should avoid assuming that all contracts traded on a regulated platform receive the same tax treatment.
The most conservative treatment for many nonbusiness prediction-market contracts tied to sports, elections, or similar events is wagering treatment. Neither the Internal Revenue Code nor the regulations define “wagering transaction” for purposes of §165(d), but IRS authorities generally look for three elements: prize, chance and consideration.
Under that framework, a prediction-market contract may be viewed as a wager where the taxpayer pays consideration for the chance to receive a payoff if a specified event occurs. The presence of skill or research does not necessarily prevent wagering characterization. Authorities addressing tournament poker and daily fantasy sports have treated those activities as wagering even though skill is involved, because elements of chance beyond the participant’s control ultimately determine the outcome.
Prediction market contracts tied to sports events, elections or other real-world events seem to meet the plain and everyday meaning of a wagering transaction, and the fact that these contracts are regulated and traded on sophisticated electronic platforms should not be determinative; courts have historically looked beyond labels and formal structures when deciding whether an activity constitutes gambling.
If prediction-market contracts are treated as wagering transactions, winnings generally would be ordinary income under §61, and losses would be subject to §165(d). For tax years before 2026, wagering losses are deductible only to the extent of gains from wagering transactions. Beginning in 2026, the deduction is further limited: the allowable deduction equals 90% of wagering losses for the year and is allowed only to the extent of wagering gains for the year. Wagering loss can be deducted only if a taxpayer itemizes deductions as opposed to taking the standard deduction.
This change, effective in 2026, can create phantom income even when a taxpayer breaks even economically. For example, if a taxpayer has $100,000 of wagering gains and $100,000 of wagering losses in 2026, only $90,000 of the losses may be deductible, leaving $10,000 of taxable income.
The most taxpayer-friendly position is to treat prediction market contracts as §1256 contracts. Section 1256 generally is favorable because it provides annual mark-to-market treatment and treats gain or loss as 60% long-term capital gain or loss and 40% short-term capital gain or loss, regardless of the taxpayer’s actual holding period. For noncorporate taxpayers, §1256 losses are capital losses. Capital losses may offset capital gains, plus up to $3,000 of ordinary income each year. Unused net capital loss generally carries forward indefinitely until absorbed.
The §1256 question addressed here is whether an event-based prediction market contract can fit within one of the relevant listed categories of §1256 contracts (i.e., regulated futures contracts and nonequity options) and not fall within the relevant exclusion (i.e., notional principal contracts (NPCs) or swaps)?
A regulated futures contract must satisfy specific statutory requirements, including a fluctuating collateral (i.e., variation margin) requirement that depends on a system of marking to market, and that the contract be traded on or subject to the rules of a qualified board or exchange (QBOE). Even though two of the more popular prediction markets (Kalshi and Polymarket US) have been designated as contract markets, and thus should be QBOEs, the event-based prediction market contracts are prepaid and not subject to a fluctuating collateral requirement; thus, these contracts likely do not qualify as regulated futures contracts.
A nonequity option is an option that is not an equity option, and the option must be traded on, or subject to the rules of, a QBOE. Case law, as applied in Saviano v. Commissioner, defines an option generally as having two characteristics:
Under another formulation, options typically reference “property,” and the purpose of an option is to provide a party the opportunity to buy or sell specified property in the future at a defined price. without the potential liability inherent in being obligated to buy or to sell. See United States Freight Co. v. United States, 422 F.2d 887, 894-95 (Ct. Cl. 1970). Options can be physically settled or cash settled.
Even though it is not obvious that a contract on a sport or political event can qualify as a nonequity option under the above definitions, reasonable arguments can be made to support this treatment for contracts that reference property such as commodities or currencies. Taxpayers taking the §1256 route should consider the specific contract at issue before taking a position, including where it is traded.
Section 1256(b)(2)(B) excludes interest rate swaps, currency swaps, basis swaps, interest rate caps, interest rate floors, commodity swaps, equity swaps, equity index swaps, credit default swaps and similar agreements. In general, an NPC is defined in Reg. 1.446-3(c) as a contract that calls for the payment of amounts by one party to another at specified intervals calculated by reference to a specified index upon a notional principal amount in exchange for specified consideration or a promise to pay similar amounts.
Most traditional binary event contracts involve a single settlement payment at expiration or resolution of the event, and that cuts against NPC treatment. However, Kalshi recently introduced a perpetual futures contract (a “perp”) that has no expiration date and requires periodic funding payments. Those features distinguish it from many binary event contracts that settle only once at termination. Periodic funding payments make perps start to look more like NPCs, which pulls them into the swap exclusion and therefore out of §1256.
If a prediction-market contract is not treated as a wager and does not qualify as a §1256 contract, it may still be analyzed as a non-wagering investment transaction. The character of gain or loss may then depend on whether the contract is an option or other right or obligation with respect to “property,” and whether that property is a capital asset in the taxpayer’s hands.
Section 1234 applies to options to buy or sell property. For the holder of an option, gain or loss from the sale or exchange of the option, or loss from failure to exercise the option, generally takes the same character as the underlying property would have in the taxpayer’s hands. Cash-settlement options are treated as options to buy or sell property for purposes of §1234.
Section 1234A is broader than §1234, but it is still tied to “property.” It applies to gain or loss attributable to the cancellation, lapse, expiration, or other termination of a right or obligation with respect to property that is, or on acquisition would be, a capital asset in the taxpayer’s hands. In 2015, the Fifth Circuit in Pilgrim’s Pride Corp. generally held that §1234A applies to the termination of rights or obligations with respect to property, and it does not apply to the termination of rights inherent in a capital asset, such as the abandonment of stock, which includes rights in the management, profits, and assets of a corporation. Section 1234A also does not apply where the referenced property is §1231 trade or business property rather than a capital asset.
Accordingly, §§1234 and 1234A are most helpful where the prediction-market contract is an option or other right or obligation with respect to property. For example, a contract referencing commodities, currency or other property may present a stronger argument for capital treatment if the referenced property is, or would be, a capital asset in the taxpayer’s hands. By contrast, if a contract is tied only to a non-property event—such as the outcome of an election, sports contest, or other event that is not itself property—§§1234 and 1234A may not supply capital treatment.
If a contract does not reference property and does not otherwise qualify for capital treatment, gain on expiration or settlement of the contract may be ordinary under the extinguishment doctrine, though a sale of the contract before expiration could produce capital gain or loss, introducing a planning opportunity. If the loss is ordinary, it may be nondeductible if the activity is a hobby (i.e., activity primarily for personal pleasure or recreation), or if it relates to an investment transaction not connected to a trade or business, because the One Big Beautiful Bill Act (OBBBA) made permanent the ban on miscellaneous itemized deductions.
If capital treatment applies, the normal capital-loss rules must still be considered. For noncorporate taxpayers, capital losses generally may offset capital gains, plus up to $3,000 of ordinary income each year. Unused net capital losses generally carry forward indefinitely until absorbed.
A separate analysis may apply if a taxpayer’s prediction-market activity rises to the level of a trade or business or is entered into as part of a hedging or risk-management activity. This will depend on the taxpayer’s facts, including the frequency and regularity of transactions, the taxpayer’s purpose, the relationship of the contracts to an existing business and whether the contracts hedge ordinary business risks.
For example, a business that uses event contracts to hedge risks directly connected with its operations may have a different tax profile from an individual who sporadically buys contracts on sports or political outcomes for personal profit or entertainment. Similarly, a taxpayer engaged in frequent, continuous and substantial prediction-market trading may raise issues different from those of a casual participant.
Trade or business treatment does not automatically avoid all limitations. If the activity is still characterized as wagering, §165(d) can limit losses even for professional gamblers. Conversely, if the activity is properly characterized as non-wagering business or hedging activity, ordinary income or loss treatment may be appropriate depending on the specific facts.
The absence of IRS guidance leaves taxpayers and advisers with significant uncertainty. Existing authorities provide analogies, but they do not answer all questions raised by modern event contracts. Prediction markets may be regulated as financial markets for some non-tax purposes, but federal income tax treatment depends on the tax rules, not regulatory labels.
Until the IRS issues guidance, prediction-market contracts should be analyzed contract by contract. The key questions are whether the taxpayer is acting in a trade or business or hedging capacity; whether the contract qualifies as a §1256 contract and avoids the NPC exclusion; whether the activity is characterized as wagering; and, if not, whether the contract is an option or other right or obligation with respect to property that is a capital asset in the taxpayer’s hands.
This is best understood as a practical screening order rather than a mechanical ranking from most to least favorable. The “best” result depends on the taxpayer’s facts and whether the taxpayer values 60/40 capital gain, ordinary loss, avoidance of §165(d) or other consequences. Taxpayers also need to consider how different states impose tax on these contracts.
Because of the uncertainty and the fact-specific nature of these contracts, taxpayers should obtain professional tax advice before applying any particular tax treatment. The tax result may vary depending on the contract’s terms, the platform on which it trades, the referenced event or property, the taxpayer’s purpose and the taxpayer’s overall activity.
For more information on this topic, please contact a member of our team.
Kimberly Ravenell, tax partner, was recognized for her commitment to client service and mentorship. With more than 30 years of experience advising high-net-worth individuals and closely held businesses, she provides tax planning and compliance guidance. Kim has played a key role in guiding her team and clients through significant industry and regulatory changes while supporting…
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