Are Prediction Market Losses Tax Deductible? Gambling vs. Capital Rules

Prediction market losses are tax deductible, but how much you can actually write off depends on how your contracts are classified. The IRS has not issued guidance specific to event contracts, so you have to place your activity into an existing framework: wagering, capital assets, or Section 1256 contracts. Each path treats losses differently, and one of them, gambling, got materially worse starting with the 2026 tax year.

Classification Drives Everything

The IRS has never published a revenue ruling, notice, or FAQ addressing prediction market contracts. That silence pushes the judgment onto you, and it happens at the contract level rather than the platform level. A contract tied to an economic indicator and a contract tied to a sporting event on the same platform can warrant different treatment because the underlying event drives the analysis.

Three frameworks are in play. If your contracts look like wagers, the strictest gambling rules apply. If they look like property bought and sold at fluctuating prices, capital gains and loss rules apply. And if contracts on a CFTC-regulated exchange qualify as Section 1256 contracts, you get a favorable 60/40 tax split. Choosing the wrong framework on your return is where audit risk lives.

If Your Activity Is Treated as Gambling

Wagering losses fall under 26 U.S.C. § 165(d). For tax years beginning after December 31, 2025, two limits stack. Only 90% of your wagering losses count toward the deduction, and that reduced amount can only offset wagering gains from the same year. The 90% cap was enacted as part of the One, Big, Beautiful Bill Act, signed July 4, 2025.¹

A concrete example. If you lost $10,000 and won $7,000 on prediction markets during 2026, 90% of your losses is $9,000, but the deduction is still capped at your $7,000 in winnings. You deduct $7,000, and the remaining $3,000 loss gives you no benefit. Flip the numbers: $10,000 in losses against $12,000 in winnings. Your 90% cap is $9,000, which is under your winnings, so you deduct $9,000 and pay tax on $3,000 of net gains. Under pre-2026 rules you would have deducted the full $10,000 against the $12,000 and paid tax on only $2,000.

You Have to Itemize

Recreational gamblers claim wagering losses only by itemizing on Schedule A. Take the standard deduction and your gambling losses do nothing for you, no matter how large.²

Wagering losses also sit in a silo. They cannot reduce wages, investment income, or anything else on the return. Losses that exceed winnings in a given year simply disappear. There is no carryover.

Professional Gamblers Get No Extra Break

Even if prediction market wagering is your full-time business, the deduction is capped at net wagering income. Section 165(d) defines “losses from wagering transactions” to include business expenses connected to the activity, so data subscriptions, platform fees, and home office costs all count against the same ceiling as the wagers themselves.¹

If Your Contracts Are Capital Assets

Capital asset treatment under 26 U.S.C. § 1221 is a much friendlier world.³ Capital losses offset capital gains from any source, not just prediction markets. Lose money on Kalshi contracts, make money selling stock, and the two net against each other.

If total capital losses exceed total capital gains, you can deduct up to $3,000 of the excess against ordinary income such as wages. Married taxpayers filing separately are capped at $1,500.⁴

Any unused loss carries to the following year and keeps its short-term or long-term character.⁵ A $15,000 prediction market loss with no offsetting gains works out to $3,000 per year for five years. Slow, but real, and categorically better than the gambling framework, where excess losses vanish.

Wash Sale Risk

If contracts are capital assets, the wash sale rule can apply. It blocks a loss when you buy a substantially identical position within 30 days before or after the sale. With event contracts this gets murky. Sell a “Will inflation exceed 3%?” contract at a loss, buy a nearly identical contract on the same event with a slightly different expiration, and an IRS examiner could argue the positions are substantially identical and disallow the loss. The IRS has not defined “substantially identical” with precision, which is a real exposure for active traders who cycle through similar positions.

Section 1256 Treatment

Some prediction market contracts on CFTC-regulated exchanges could potentially qualify as Section 1256 contracts. If they do, 60% of gains and losses are treated as long-term and 40% as short-term regardless of how long you held the position. For losses, the split determines the character of the capital loss carryover; for gains, it produces a lower blended rate than pure short-term treatment.

Whether event contracts on platforms like Kalshi actually qualify is unsettled, and the IRS has not confirmed or denied it. Taking this position means reporting on Form 6781 rather than Schedule D.⁶ Some tax professionals support it for CFTC-regulated contracts, but the absence of direct guidance carries audit risk.

Trader Status and the Mark-to-Market Election

If you trade often and heavily enough to qualify as a trader in securities, a Section 475(f) mark-to-market election converts capital gains and losses into ordinary income and ordinary losses. The payoff is that ordinary losses are not subject to the $3,000 annual cap. They can fully offset wages, business income, and other income on the return.⁷

Qualifying is difficult. The IRS looks at trading frequency, whether you hold positions briefly to capture short-term price movement rather than long-term appreciation, and whether you devote substantial time to it on a regular basis. Placing a handful of contracts per month will not qualify you.⁷

The election has a hard deadline. You must file a statement with the return for the year before the election takes effect. To elect for 2026, the statement had to be attached to your 2025 return or your 2025 extension request. New taxpayers who were not required to file for the prior year get a limited exception: they can place the election statement in their books and records within two months and 15 days of the start of the election year.⁷

Records and Forms

Most platforms do not issue the clean tax documents a traditional brokerage would. Kalshi provides profit-and-loss summaries and may issue Forms 1099-INT or 1099-MISC for non-contract activity like interest or bonuses, but it does not resolve the classification of your event contract trades. Other platforms are less helpful still. The burden of computing gains, losses, and cost basis is on you.

For every contract, keep:

Purchase date and price
Sale or settlement date and proceeds
Platform fees, which adjust basis
A description of the underlying event, since characterization can differ by contract

A contract that resolves against you is not a non-event for tax purposes. It is a disposition with zero proceeds, producing a loss equal to what you paid. Export your transaction history regularly, since platforms can change, shut down, or lose data.

The form you use depends on your classification:

Gambling: report winnings as other income; claim losses as other itemized deductions on Schedule A.²
Capital asset: report transactions on Form 8949 and summarize on Schedule D.⁸
Section 1256: report on Form 6781, which flows into Schedule D.⁶
Mark-to-market: report on Schedule D and Form 8949, with gains and losses treated as ordinary.⁷

Platform Notes That Affect Your Position

Kalshi operates as a CFTC-designated contract market, which gives its contracts a stronger argument for capital asset or Section 1256 treatment than an unregulated venue. CFTC registration alone does not settle the tax question, and Kalshi’s own P&L tools compute numbers without telling you how to classify the activity.

Polymarket blocks US-based users under its terms of service. A US person who traded on Polymarket anyway still owes tax on gains, and the absence of any tax documents makes record-keeping harder. Polymarket also runs on cryptocurrency, which can produce its own taxable events on the crypto side, separate from whether the underlying event contract won or lost.

State Taxes

Federal rules are only part of the picture. States treat gambling loss deductions differently, from full conformity with the federal rule to complete disallowance. If your activity is classified as gambling, you could owe state tax on gross winnings with no loss offset, depending on where you live. State treatment of capital losses generally tracks federal rules more closely, but not universally. Check your state’s conformity provisions before assuming your federal classification carries over.

1
Office of the Law Revision Counsel. 26 USC 165 – Losses
2
Internal Revenue Service. Topic No. 419, Gambling Income and Losses
3
Office of the Law Revision Counsel. 26 U.S. Code 1221 – Capital Asset Defined
4
Office of the Law Revision Counsel. 26 USC 1211 – Limitation on Capital Losses
5
Office of the Law Revision Counsel. 26 USC 1212 – Capital Loss Carrybacks and Carryovers
6
Internal Revenue Service. About Form 6781, Gains and Losses From Section 1256 Contracts and Straddles
7
Internal Revenue Service. Topic No. 429, Traders in Securities
8
Internal Revenue Service. About Schedule D (Form 1040), Capital Gains and Losses