How Are Prediction Markets Taxed?

Crypto prediction markets are booming, but winnings aren’t tax-free. The good news is that they may be taxed more favorably than traditional gambling winnings.

Are prediction markets taxed?

Yes. Whether you’re using Polymarkets, Kalshi, or another app entirely, any winnings from prediction markets are taxable.

Given the IRS's stance that traditional gambling winnings are taxable upon receipt, many would assume the same stance applies to prediction market winnings.

But because of the way specific protocols work, the existing IRS guidance on crypto, and the lack of guidance specifically on prediction market winnings, there is a lot of grey area for tax experts to attempt to navigate. 

How do prediction market protocols work?

To understand how prediction markets are taxed, you need to understand how they’re structured.

Traditional gambling involves placing a wager with a bookmaker or casino. If you win, the operator pays you out. There’s no asset being bought or sold, just a bet that resolves to cash.

Prediction markets work differently. Instead of betting against a house, users buy and sell contracts that represent outcomes, and these contracts behave much more like financial instruments than bets.

This is easier to understand with an example.

In other words, in crypto prediction markets, users typically acquire an asset (a contract or token) and later dispose of it, either by selling it or letting it settle.

That means these transactions may resemble something more akin to event-based derivatives or spot trades, rather than traditional gambling, where there is no asset ownership.

How are prediction market winnings taxed?

There is no official guidance from the IRS, so speak to an experienced accountant, but the tax treatment depends on the framework you rely on to interpret your transactions and your specific protocol, and how you’re transacting USDC/USDT vs USD.

The three most common approaches currently are to treat winnings as:

• Capital gains/losses

• Ordinary income

• Gambling income

Capital gains/losses

This approach treats Polymarket positions as capital assets under Internal Revenue Code §1221, with each trade falling under the general gain/loss rules in §1001.

In simple terms, you’re taxed the same way you would be when selling stocks or crypto: you calculate the difference between what you paid (basis) and what you received (amount realized). That difference is a capital gain or loss.

The logic for this approach comes from how the IRS already treats crypto as property rather than currency.

Because Polymarket uses assets like USDC and involves buying and selling positions that fluctuate in value, many tax experts extend that same framework here. If you hold a position for under a year, any gain is short-term and taxed at ordinary income rates; over a year, it’ll benefit from lower capital gains tax rates.

This approach is one of the most common for prediction market winnings currently, as it aligns well with existing IRS guidance on crypto, as well as allowing investors to deduct losses.

Ordinary income

Under this approach, profits are treated as ordinary income under §61 of the Internal Revenue Code, which defines gross income very broadly as “all income from whatever source derived.”

Instead of characterizing trades as sales of capital assets, you treat the activity more like earning money directly. Your net profit over a period is included in income and taxed at standard marginal rates, the same way wages or freelance earnings would be.

The rationale behind this approach is that if an activity doesn’t clearly fall into a more specific category, the IRS can default to ordinary income treatment. This is especially relevant if someone is trading frequently or in a way that looks more like active income generation than passive investment.

The advantage is that it’s conservative and harder for the IRS to challenge, since §61 is intentionally broad. The drawback is that you lose access to preferential capital gains rates, and loss treatment can be more restrictive depending on how the activity is characterized (e.g., hobby vs. trade or business).

Gambling income

This method applies the wagering rules under §165(d) of the Internal Revenue Code. Under this framework, Polymarket activity is treated like betting: all winnings are fully taxable, and losses are only deductible to the extent of winnings.

The reasoning behind this approach is pretty self-explanatory. Prediction markets involve staking money on uncertain outcomes, which resembles gambling.

Under this treatment, you would report gross winnings as income and then separately deduct losses, but only up to the amount of those winnings. You cannot use excess losses to offset other income.

The issue is that Polymarket is structured more like a tradable market with pricing, liquidity, and exit opportunities before resolution, which weakens the analogy to traditional gambling in the eyes of many tax professionals.

Because of that, this approach is less common and potentially more vulnerable to challenge. It also tends to be less tax-efficient due to the strict loss limitation rules.

In practice, all three approaches may be defensible in the absence of any specific guidance from the IRS, provided you (or your accountant) takes a reasonable and consistent position with excellent documentation.

All that said, let’s take a look at specific transactions and the potential tax treatment that may arise under the most common approach for crypto prediction market winnings specifically.

How are specific transactions taxed?

The simplest way to follow the different taxable events of prediction markets is to break them down by what happens to your position over time.

Buying prediction market shares or tokens

Buying “yes” or “no” shares may or may not be a taxable event, depending on how you pay.

If you buy shares with fiat currency, this is not a taxable event. You’re simply acquiring an asset, and the purchase price (plus fees) becomes your cost basis.

However, if you buy shares using cryptocurrency (e.g., USDC, ETH, USDT, or another token), then this is a disposal and therefore a taxable event.

You’ll trigger a capital gain or loss on the crypto you’ve spent/traded, and your prediction market shares receive a new cost basis equal to their fair market value at purchase

Selling prediction market shares or tokens

Selling “yes” or “no” shares before a market resolves is typically a taxable disposal.

Because prediction market shares and tokens are treated as capital assets, selling them triggers a capital gain or capital loss, calculated as: sale proceeds − cost basis.

Owning “yes” shares when the market settles to “yes”

When a market resolves and your outcome is correct, the shares settle to their full payout value (typically $1, 1 USDT, etc.).

This is generally treated as a disposal of the asset at settlement value, creating a capital gain. It’s economically similar to holding a derivative contract until expiration.

For most protocols, you need to redeem your winnings. For example, with Polymarket, you can burn your shares after the market settles. You also have to claim your winnings. While there is no official guidance, this is likely the point at which the taxable event occurs, resulting in a capital gain.

Owning “yes” shares when the market settles to “no”

If the market resolves against your position, your shares become worthless.

This typically creates a capital loss equal to your cost basis, although you may need to burn your shares after the market settles in order to realize your loss.

What about when the market invalidates?

Sometimes a market may be invalidated, for example, due to an event cancellation or if a specific condition isn’t met within a given timeframe.

In these instances, most markets have a predetermined split rule where if a market is invalidated, then proceeds from the market are split 50:50 to yes/no. 

In this instance, to calculate your gain/loss, you’ll need to subtract your cost basis (your original investment) from your proceeds (settlement).

Do short-term vs. long-term capital gains tax rules apply?

There is no clear IRS guidance on how holding period rules apply to prediction market contracts.

It is assumed that these positions will be treated as ordinary capital assets, meaning gains are short-term if held for one year or less and long-term if held for more than a year. In practice, most prediction market trades will fall into short-term treatment because generally markets resolve quickly.

However, there is an argument that some contracts, particularly on CFTC-regulated platforms like Kalshi, could qualify as Section 1256 contracts. If so, they would receive special tax treatment:

• 60% of gains are taxed as long-term capital gains

• 40% taxed as short-term capital gains

• This split applies regardless of how long you held the position

• Positions may also be subject to mark-to-market treatment at year-end

That said, the classification is unresolved. Some practitioners argue that prediction market contracts may not meet Section 1256 criteria because their payouts are event-based rather than tied to fluctuating underlying asset prices, potentially pushing them toward treatment as ordinary capital assets or even ordinary income in aggressive interpretations.

Does Koinly handle crypto prediction markets?

Yes. Koinly supports Polymarket for crypto transactions. These are imported as ERC-1155 trades.

We take the most common approach to tax treatment (capital gain/loss treatment), and apply the existing crypto IRS guidance to your prediction market transactions. 

Just connect your wallet, import your transaction history, and let Koinly calculate your gains and losses. Try it free today.