Section 1256 of the Internal Revenue Code provides a favorable tax treatment for certain regulated futures contracts: 60% of gains are taxed as long-term capital gains and 40% as short-term, regardless of holding period. For high-income traders, this can mean the difference between a 37% tax rate and an effective rate around 26%. The question: do Kalshi prediction market contracts qualify?
What is Section 1256?
Section 1256 covers "regulated futures contracts" traded on qualified exchanges:
- 60/40 rule: Regardless of how long you held the contract, 60% of gains are taxed at the long-term capital gains rate (0%, 15%, or 20%) and 40% at ordinary income rates.
- Mark-to-market: Open positions are treated as if sold at year-end fair market value. You report unrealized gains/losses annually.
- Loss carryback: Net Section 1256 losses can be carried back three years against prior Section 1256 gains.
Why it matters: For a trader in the 37% federal bracket, ordinary short-term gains are taxed at 37%. Under Section 1256, the effective rate drops to about 26.8% (60% × 20% + 40% × 37%). That's a significant difference on large trading volumes.
Do Kalshi contracts qualify?
This is an unsettled legal question. Here's the argument on both sides:
Arguments for Section 1256 treatment:
- Kalshi is a CFTC-designated contract market (DCM)—the same designation held by CME and other futures exchanges.
- Kalshi contracts are "regulated" by the CFTC under the Commodity Exchange Act.
- The IRS defines Section 1256 contracts as "regulated futures contracts" on "qualified boards of exchange."
- Kalshi is a qualified board of exchange under CFTC rules.
Arguments against:
- Section 1256 was written for traditional futures (commodities, interest rates, currencies). Event contracts may not fit the definition.
- The IRS has not issued specific guidance on event contracts under Section 1256.
- Some tax professionals argue event contracts are more like options or "other" derivatives, not futures contracts.
- The mark-to-market requirement may not map cleanly to binary contracts that are either 0 or 1.
Current IRS guidance
As of 2026, the IRS has not issued definitive guidance on whether CFTC-regulated event contracts qualify for Section 1256. This means:
- No safe harbor: There's no IRS ruling or revenue procedure that clearly says event contracts are Section 1256 contracts.
- No prohibition: There's also no ruling that explicitly says they don't qualify.
- Aggressive vs. conservative: Claiming Section 1256 treatment for Kalshi contracts is an aggressive tax position. It may be defensible but carries audit risk.
What should traders do?
- Conservative approach: Report Kalshi gains as short-term capital gains. This is the safest approach with zero audit risk.
- Aggressive approach: Report under Section 1256 with the 60/40 split. Be prepared to defend the position if audited.
- Get professional advice: If you have significant trading volume, consult a tax attorney or CPA who specializes in derivatives taxation. The cost of advice is far less than the potential tax savings (or penalties).
- Document your position: If you claim Section 1256, document your reasoning. Note that Kalshi is a CFTC DCM and cite the relevant IRS code sections.
- Watch for guidance: The IRS may issue guidance as prediction markets grow. Stay informed through tax professional networks.
Does Polymarket qualify for Section 1256?
Almost certainly not. Section 1256 requires contracts to be traded on a "qualified board of exchange" regulated by the CFTC. Polymarket is:
- Not CFTC-regulated
- Not a US-registered exchange
- Crypto-native, operating on Polygon
Polymarket gains should be reported as standard capital gains, likely short-term for most traders.
Make informed decisions with Alphascope
Alphascope helps you maximize your prediction market returns—consult a tax professional to keep more of those returns:
- Predictions → Find the best opportunities across both platforms.
- Arbitrage → Cross-platform trading may have different tax implications for each side.
FAQ
Can I use Section 1256 for Kalshi taxes?
The IRS hasn't ruled definitively. There's a reasonable argument that CFTC-regulated Kalshi contracts qualify, but it's an aggressive position. Consult a tax professional before claiming this treatment.
What's the tax difference between Section 1256 and regular short-term gains?
For a trader in the 37% bracket, Section 1256's 60/40 rule results in an effective rate of about 26.8% vs. 37% for straight short-term gains. On $100K in profits, that's roughly $10,000 in tax savings.
Should I amend past returns to claim Section 1256?
Possibly, if the amounts are significant and a tax professional advises it's defensible. Section 1256 losses can even be carried back three years. But the audit risk should be weighed carefully.