The Tax Advantage Nobody Talks About
Prediction market traders on Kalshi benefit from a tax treatment that most participants do not understand and many financial advisors have never encountered. Kalshi contracts are classified as CFTC-regulated event contracts, which means they receive Section 1256 treatment under the Internal Revenue Code. This is the same tax treatment that applies to regulated futures contracts and broad-based index options. The result: a blended tax rate that is significantly lower than ordinary income rates. If you are profitable in prediction markets and not structuring your taxes correctly, you are leaving money on the table.
Section 1256: The 60/40 Rule
Under Section 1256, gains from qualifying contracts are taxed as 60% long-term capital gains and 40% short-term capital gains, regardless of how long you held the position. This means even if you bought a contract at 9 AM and sold it at 10 AM, 60% of your gain is taxed at the long-term rate (currently 20% maximum federal) and only 40% at the short-term rate (currently 37% maximum federal).
The blended rate for top-bracket earners: 0.60 × 20% + 0.40 × 37% = 12% + 14.8% = 26.8%. Compare this to the ordinary income rate of 37% that applies to short-term stock trading gains, sports betting winnings, or freelance income. The difference is 10.2 percentage points. On $50,000 of annual prediction market profits, the Section 1256 treatment saves approximately $5,100 in federal taxes. On $100,000 of profits, the savings are approximately $10,200. This is real money that accrues to every profitable Kalshi trader automatically.
For traders in lower tax brackets, the advantage is smaller but still meaningful. At the 24% ordinary income bracket, the blended 1256 rate is approximately 21.6% — a 2.4 percentage point savings. At the 32% bracket, the blended rate is approximately 24.8% — a 7.2 percentage point savings. The higher your marginal tax rate, the more valuable Section 1256 treatment becomes.
Mark-to-Market Rules
Section 1256 contracts are subject to mark-to-market rules at year-end. This means all open positions on December 31 are treated as if they were sold at their fair market value, and the resulting gain or loss is recognized for that tax year. You do not need to actually close the position — the tax is owed on the unrealized gain.
This has practical implications for year-end tax planning. If you hold a contract that has appreciated significantly and want to defer the gain, you cannot simply hold the position into January — the mark-to-market rule captures the gain on December 31 regardless. Conversely, if you hold a losing position, the mark-to-market rule allows you to recognize the loss in the current year even if you continue to hold the position into the next year. This is a useful tax-loss harvesting mechanism that equity traders do not have (they must actually sell the position to realize a loss).
Loss Treatment
Section 1256 losses receive the same 60/40 treatment as gains — and can be carried back three years. This is unique. Most capital losses can only offset capital gains in the current year (with a $3,000 deduction against ordinary income for excess losses) and carry forward indefinitely. Section 1256 losses can be carried back to offset Section 1256 gains in the three prior years, potentially generating a tax refund from previously paid taxes.
The carryback provision is powerful in volatile years. If you earned $50,000 in prediction market profits in 2024 and 2025 but lost $30,000 in 2026, you can carry the 2026 loss back and amend your 2024 or 2025 returns to recover taxes paid on $30,000 of gains. The IRS processes amended returns in 6-12 months and issues refunds with interest. No other asset class provides this three-year carryback for individual traders.
Kalshi vs. Polymarket: Tax Differences
Kalshi issues 1099-B forms for all settled contracts, making tax reporting straightforward. The 1099-B categorizes each contract settlement as a Section 1256 transaction. Your tax software (TurboTax, H&R Block) or CPA can process these forms and apply the 60/40 treatment automatically.
Polymarket does not issue 1099s. Because trades occur on-chain using cryptocurrency, the tax reporting burden falls entirely on the trader. Each trade must be tracked — the USDC cost basis, the settlement proceeds, and the holding period. The IRS treats crypto-based prediction market gains as either capital gains (if the contracts qualify as capital assets) or ordinary income (if they do not). The classification is ambiguous and depends on factors including the trader's intent, frequency of trading, and the nature of the contracts.
The safest approach for Polymarket traders: treat gains as short-term capital gains (ordinary income rates) unless a tax professional advises otherwise. This is the most conservative treatment and avoids potential penalties from the IRS. The disadvantage: you lose the Section 1256 tax advantage that Kalshi traders receive automatically. For US-based traders generating significant profits, this tax differential is a compelling reason to use Kalshi over Polymarket, even when Polymarket offers better prices or more market variety.
Record-Keeping Requirements
The IRS expects detailed records of all prediction market activity. For each trade, maintain: the contract description, the purchase date and price, the settlement or sale date and price, and the gain or loss. Kalshi provides this in your account transaction history and on your 1099-B. Export the data at year-end and store it with your tax records.
For Polymarket, you need to build your own records. Export your on-chain transaction history from PolygonScan, correlate trades with contract descriptions (Polymarket's API provides this mapping), and calculate gains and losses in USD terms using the USDC exchange rate at the time of each trade (USDC is approximately 1:1 with USD, but minor deviations matter for accurate reporting).
Professional prediction market traders use portfolio tracking software that integrates with both Kalshi and Polymarket APIs. Tools like Koinly, CoinTracker, and custom spreadsheets can automate the record-keeping process. The setup time is a few hours per year. The alternative — reconstructing your trading history at tax time from incomplete records — is a nightmare that compounds every year you delay.
When to Consult a Professional
If your annual prediction market profits exceed $10,000, consult a CPA familiar with Section 1256 contracts. The tax savings from proper structuring will exceed the CPA's fees. If you trade on both Kalshi and Polymarket, the cross-platform tax implications add complexity that generic tax software may not handle correctly. If you are considering trading prediction markets as a business (electing trader tax status under Section 475), the implications for self-employment tax, business expense deductions, and estimated tax payments require professional guidance.
The prediction market tax landscape is favorable for informed traders. Section 1256 treatment, 60/40 blended rates, three-year loss carryback, and mark-to-market rules provide structural advantages that few other asset classes offer individual traders. But these advantages only materialize if you know they exist and structure your reporting accordingly. Knowledge is edge — in prediction markets and in the tax code.
