The usage of prediction markets to make bets has grown exponentially, with names like Kalshi and Underdog becoming household names in advertisements and market branding. Part of the prediction market company’s appeal is that it gives people the ability to wager money on sporting events even when they live in a state where legal sports gambling is not currently allowed. However, the tax code and a generous interpretation of how income from prediction market wagers should be treated for tax purposes suggest there are monetary benefits to using prediction markets for sports wagers. This article summarizes the tax treatment of prediction market wagers and how the “60/40” rule may yield significant prediction markets tax benefits for gamblers relative to traditional sports betting.
Sports Gambling Tax Treatment Differs From Prediction Markets
Like most other transactions involving money, making wagers using a prediction market has tax consequences. For instance, if one were to wager $550 that the Pittsburgh Steelers beat the Miami Dolphins by more than 3 points, that taxpayer would typically receive about $500 in winnings, increasing their taxable income by $500. The taxpayer would then owe taxes on that $500 of income.
As I outline in a Forbes contributor article, under traditional sports betting markets, this $100 of income would be taxed as ordinary income. The taxpayer would only be able to deduct losses to the extent of gains, and these losses can only be deductible if the taxpayer itemizes their taxes, meaning they have more than $15,750 in itemized deductions in 2025.
Prediction Markets Tax Benefits
Prediction markets like Kalshi and Underdog do not offer sports betting as commonly defined and regulated by U.S. states. Instead, they allow taxpayers to bet on predictions for the future. Although economically similar to sports wagers, prediction market contracts are legally structured as event-based financial contracts rather than bets. These entities are structured and licensed under the U.S. Commodity Futures Trading Commission. Under this licensing, many taxpayers and practitioners currently take the position that certain prediction market contracts may qualify as Section 1256 contracts.
While there is some debate as to whether these types of transactions will always be offered under Section 1256, as suggested by KPMG, which outlines the numerous alternative ways these transactions might be handled for tax purposes, the fact remains that there is little guidance being provided to say that they are not futures contracts. In fact, Axios reported that Kalshi’s own CEO claims these sports event contracts are not gambling and should be
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As I discuss in a Forbes contributor piece, Section 1256 contracts offer three unique advantages over a typical sports gambling wager: (1) the losses from Section 1256 contracts can be deducted against earnings, (2) the losses from Section 1256 contracts can be used to lower ordinary income, and (3) Section 1256 contracts are marked to market annually and reported on a net gain or loss basis, unlike gambling winnings which are taxed on a gross-winnings basis.
Explaining The 60/40 Rule For Earnings From Prediction Markets And How It Offers Prediction Markets Tax Benefits
Many practitioners treat these contracts as governed under Section 1256, applying the 60/40 rule to divide income. Under this Internal Revenue Code section, any gain or loss should be divided up as 60% being a long-term capital gain or loss and 40% being a short-term capital gain or loss.
For instance, take a taxpayer who purchases a $1,000 oil future. Upon expiration at the end of the year, this future is worth $1,500. Under this situation, the $500 gain would be treated as capital. $300 (or 60%) would be taxed at a long-term capital gains tax rate, and $200 (40%) would be taxed at a short-term capital gains tax rate. Assuming this taxpayer is in the top income tax bracket, the transaction would result in $134 of tax liability ($300 * 20% + $200 * 37%) excluding state taxes, net investment income tax, and other individual-specific considerations.
Assuming that sports betting contracts from providers governed by the U.S. Commodity Futures Trading Commission fall under Section 1256, the exact same treatment would occur. For example, if a taxpayer made that same $550 wager for the Steelers to cover the spread via a prediction market contract, the $500 in earnings would result in a $134 tax liability.
Meanwhile, if the same wager were made using DraftKings, the taxpayer would owe $185 in taxes as all $500 of earnings would be subject to the 37% income tax rate. Put differently, the same wager would yield $51 more – almost 10% of the $550 bet—when made on a prediction market relative to a sports gambling website.
In addition to the tax rate benefits, the 60/40 rule allows taxpayers to treat their earnings from prediction markets as capital income. In the U.S., capital gains can receive the preferential tax rate outlined above, but capital losses can be equally valuable. For instance, losses can offset capital gains and, to a limited extent, ordinary income.
Will Prediction Markets Tax Benefits Be Erased By The Wagers Being Reclassified As Gambling For Tax Purposes?
While the current treatment for wagers made via prediction markets is to consider them as Section 1256 contracts, there is substantial tension as to whether or not they should be. As reported by MorningStar, advocates from the American Gaming Association are fighting hard to reclassify these actions as sports gambling and subject to state regulation and U.S. and state gambling tax laws. While their efforts to make constructive changes before the end of 2025 appear limited, those using Kalshi or Underdog (for some of Underdog’s offerings) due to the enhanced tax benefits need to be aware that changing these wagers to be sports bets for tax purposes could significantly impede those benefits.
Despite the uncertainty over whether prediction market wagers will be reclassified to sports gambling for tax purposes, some taxpayers may view the current environment as favorable, though regulatory risk remains significant. Currently, sports gambling is still not permitted in the two most populated states in the U.S. — California and Texas –– as well as nine other states. Furthermore, starting in 2026, gambling losses will only be able to be 90% deductible as an itemized expense. Thus, the prediction markets tax benefits will only grow as we head into the new year.