Last Updated on July 19, 2026 by Patrick Camuso, CPA
Quick answer (read this first):
The short answer: It depends on how your prediction market activity is characterized, on your capacity as a taxpayer, and on how each position ended, and the rules differ significantly across those variables.
Why prediction market loss deductions matter: Under capital treatment, losses net against capital gains and excess capital losses carry forward. Ordinary character alone does not establish that a loss is deductible. For an individual, an otherwise allowable ordinary nonbusiness loss that is not from a sale or exchange is a miscellaneous itemized deduction currently disallowed under Section 67(h). Under gambling treatment, losses are deductible only against wagering gains, generally only if you itemize, and beginning in 2026, only up to 90 percent of losses.
What the IRS has not done: Issued any notice, ruling, or guidance that resolves how prediction market contracts should be characterized. Until the IRS does, loss treatment is determined by the framework applied, and that framework is a documented analytical decision.
The practical posture: Loss treatment is one of the three most consequential differences between characterization frameworks, alongside rate and the 2026 phantom income problem. It should be analyzed before filing, not after losses have already been reported in a way that cannot be defended.
Why Loss Treatment Matters
Most public commentary on prediction market taxes focuses on rates. The gambling versus capital gains discussion typically centers on which rate is lower, which framework is more favorable, and whether Section 1256’s 60/40 blended rate is available.
For most active prediction market traders, positions are short-duration. They open and close within days or weeks. There is usually no practical rate difference between short-term capital gain treatment and ordinary income treatment. Both are taxed at ordinary rates.
The rules governing what a trader can do with prediction market losses vary dramatically across the available characterization frameworks, the taxpayer’s capacity, and the way each position ends, and those differences compound materially at scale. A trader generating $1,000,000 in gross activity across a year, wins and losses roughly offsetting, faces a fundamentally different tax outcome depending on which loss framework applies. Understanding those differences is the starting point for any defensible prediction market reporting strategy.
How Loss Treatment Works Under Each Framework
Under Section 1001, gain or loss is measured against adjusted basis when there is a sale or other disposition of property, and allows a deduction only for a bona fide loss fixed by an identifiable event and evidenced by a closed and completed transaction. A position that has merely declined in value has not yet produced a loss for tax purposes.
The way a position ends can affect both character and deductibility. An actual pre-resolution transfer of the contract right to another participant for consideration is a sale. A contract held through automatic resolution, including one that settles at zero, may instead settle or terminate under its own terms. Whether that endpoint is treated as a sale or exchange, an option lapse, a Section 1234A termination, abandonment, worthlessness, or another disposition depends on the contract terms and platform mechanics and should not be assumed generically.
Once a loss is realized, the characterization framework, the taxpayer’s capacity, and the applicable limitation provisions determine how the loss is treated. Those steps are analyzed separately below.
Capital Gain or Loss Treatment
Under capital treatment, prediction market contracts are analyzed as property under the capital asset rules of Section 1221. Gains and losses from sales or exchanges are netted against each other at year end. Short-term capital losses offset short-term capital gains first, then long-term capital gains. Long-term capital losses offset long-term capital gains first, then short-term capital gains. Capital loss treatment requires both a capital asset and a sale or exchange, or a Code provision that treats the applicable endpoint as one. An actual transfer of the contract right before resolution may satisfy the sale requirement. A contract held through automatic resolution should not be assumed to satisfy it without examining the contract and platform mechanics.
Where net capital losses exceed net capital gains for the year, the excess is deductible against ordinary income up to $3,000 per year for individual filers ($1,500 for married filing separately). Losses beyond that limit carry forward indefinitely into future tax years under Section 1212(b), available to offset future capital gains or up to $3,000 of ordinary income per year until exhausted. For a prediction market trader with a net losing year, capital treatment produces a real, usable loss benefit. The $3,000 annual deduction against ordinary income is modest, but the carryforward has no expiration date. A trader with $50,000 in net capital losses in Year 1 retains that loss and applies it forward against gains in subsequent years.
The capital treatment loss framework also allows prediction market losses to offset capital gains from other investments. A trader who lost money on Kalshi contracts but realized gains from stock positions can offset those gains with prediction market losses, reducing the tax on the equity portfolio. That cross-asset offsetting is not available under gambling treatment.
Ordinary Income Treatment
Ordinary character describes the character of a loss; it does not by itself establish recognition, deductibility, placement, or utilization. Business losses and losses from sales or exchanges follow different deduction rules.
For an individual investor, if an otherwise allowable ordinary loss is nonbusiness and does not arise from a sale or exchange, the loss is a miscellaneous itemized deduction. Under current federal law, Section 67(h) disallows miscellaneous itemized deductions.
Ordinary income treatment and gambling treatment are not the same framework. Ordinary income from a financial contract and ordinary income from wagering produce ordinary income at the same rate, but the loss rules are entirely different.
Gambling and Wagering Treatment
If prediction-market activity is treated as wagering, the taxpayer must first determine an appropriate transaction or session unit for measuring gross wagering gains and losses. Published guidance does not define a session for continuous prediction-market trading. Notice 2015-21 proposed an optional safe harbor for electronically tracked slot-machine play only; it is not a prediction-market rule, and it expressly does not permit gains and losses from separate sessions to be netted against each other. Under the general structure of the wagering rules, positive units are aggregated as wagering gains and negative units as wagering losses for the year, and then apply the annual loss limitation.
For taxable years beginning after December 31, 2025, Section 165(d) allows a deduction equal to 90 percent of wagering losses, and only to the extent of wagering gains for the year. Net losses beyond those limits produce no tax benefit. There is no ability to offset capital gains or other income. A trader who loses more than they win in a year under gambling treatment receives no tax benefit from the excess losses, regardless of the amount. For a casual participants, wagering losses are deductible only as an itemized deduction on Schedule A. A casual trader who takes the standard deduction receives no deduction for wagering losses.
The unit-of-account question creates a compliance problem specific to prediction market traders. For casino gamblers, courts and IRS administrative guidance have approached gains and losses on a session basis rather than bet by bet, and the IRS has proposed a session safe harbor for electronically tracked slot machine play. Nothing equivalent exists for prediction market contract trading, where dozens of contracts may open, settle, and expire on any given day across multiple event types. What constitutes an appropriate transaction or session unit in that context is undefined under current guidance. That ambiguity creates a documentation burden and interpretive risk specific to the wagering framework.
Practitioners applying the gambling framework must adopt and document a measurement methodology, whether organized by contract, calendar day, market category, or another defensible division and apply it consistently across the full year. That choice directly affects the calculation of gross wagering gains reportable as income and the ceiling on deductible losses. Two practitioners applying different unit definitions to identical trading activity may produce different gross income figures and different deductible loss amounts even before reaching the 90 percent limitation.
A separate framework applies to traders who meet the legal standard for professional gambler status if gambling is pursued “full time, in good faith, and with regularity, to the production of income for a livelihood” can constitute a trade or business under Section 162. A professional gambler reports wagering income and losses on Schedule C rather than deducting losses on Schedule A, which removes the itemization limitation. A professional gambler’s wagering losses remain deductible only within the Section 165(d) limits. Professional gambler status is a facts-and-circumstances question worth analyzing for high-volume traders.
The 2026 Loss Limitation: Why Gambling Treatment Got Materially Worse
Beginning with taxable years starting January 1, 2026, the One Big Beautiful Bill Act changed the gambling loss deduction in a way that significantly increases the economic stakes of gambling characterization for active traders.
Prior to 2026, a taxpayer who itemized could deduct gambling losses up to the full amount of gambling winnings for the year. A trader with $300,000 in gross winnings and $300,000 in gross losses could deduct $300,000 against $300,000, producing zero net taxable gambling income. Beginning in 2026, the deduction for wagering losses is 90 percent of those losses, still capped at wagering gains. For a breakeven year in which measured wagering gains equal measured wagering losses, 10 percent of the measured losses is disallowed, leaving an equal amount of wagering gains taxable.
A trader with $300,000 in gross winnings and $300,000 in gross losses breaks even economically. Under the 2026 rule, deductible losses are capped at $270,000 (90 percent of $300,000). The remaining $30,000 is phantom income, taxable, unavoidable, and entirely unconnected to any economic gain from the activity. At a 37 percent marginal rate, the federal tax on that phantom income is $11,100. The trader broke even and owes over $11,000.
At higher trading volumes the numbers grow quickly. A trader with $1,000,000 in gross winnings and $1,000,000 in gross losses faces $100,000 in phantom income and a federal tax bill approaching $37,000 on a year with zero net profit.
How Platform Reporting Affects Loss Documentation
Platform reports, profit-and-loss statements, annual statements, and tax documents vary by platform, change over time, and do not determine the federal tax classification of prediction market activity or the legally required methodology. Whatever a platform provides is a starting point for reconciliation, not a conclusion. The governing principle is that records must support the treatment adopted including the characterization applied, the way each position ended, the basis and proceeds behind each reported amount, and the reporting positions taken.
Where gambling treatment applies, records must additionally support the wagering measurement methodology adopted including gross wagering gains and losses computed by the documented transaction or session unit the taxpayer uses that is consistent with the substantiation expectations the IRS has long applied to wagering. Because no published guidance defines the unit for prediction markets, the methodology itself should be documented and applied consistently.
For a detailed breakdown of what forms cover and what they omit, see our prediction market tax guide.
Characterization Is a Facts-Based Determination, Not a Selection
Tax characterization for prediction market contracts is not a choice a trader makes at filing time. It is a legal conclusion that follows from analyzing the specific contracts traded, the platform they were traded on, the regulatory structure governing that platform, the nature of the underlying events, and the taxpayer’s own capacity and use of the contracts. A trader cannot select capital treatment because it produces a better loss outcome, then switch to ordinary income treatment in a year where that produces a better result. The framework is determined by the facts. It applies consistently once a defensible position is established, and materially different contract types in the same account may require separate analysis.
This matters most in the context of losses because the economic differences across frameworks, capacities, and endpoints are largest there. A trader who assumes capital treatment without analyzing whether the facts support it is not making a planning choice. They are taking an undocumented position on an unsettled legal question. If the IRS concludes on examination that gambling treatment applies, the capital loss offsets used against other investment gains are unwound, the wagering measurement and limitation rules apply retroactively, and the 2026 disallowance calculation may produce additional tax on years already filed. The exposure compounds across every year the position was applied.
An examiner reviewing prediction market activity will likely evaluate the underlying contracts on their merits and apply the framework supported by those facts. A return supported by a documented, sequential analytical position that explains the reasoning and applies it consistently is materially more defensible than one where characterization was assumed or selected for rate purposes.
Reporting mechanics follow characterization and capacity, and they are not interchangeable. Under capital treatment, dispositions are reported on Form 8949 with net amounts flowing to Schedule D. Reporting for a nonbusiness ordinary position depends on the concluded measurement, character, and deduction treatment and should not be prescribed generically without that analysis. Under gambling treatment, gross wagering gains are reported as income and a casual participant’s wagering losses are claimed as an itemized deduction on Schedule A subject to the Section 165(d) limits. Assigning income to the wrong schedule is a separate reporting error from the characterization decision itself.
One compliance issue that surfaces after the return is filed but originates in characterization decisions made during the year is estimated tax and underpayment penalties. Traders with material prediction market gains recognized mid-year who assumed annual loss netting would offset their liability may be significantly underwithheld. The OBBBA phantom income problem compounds this for 2026. A trader who breaks even economically may owe tax attributable to the 2026 wagering-loss disallowance if withholding or estimated payments do not cover the resulting liability.
Our prediction market tax reporting services are built around exactly this problem, establishing a defensible characterization framework, applying it consistently, and documenting it in a way that holds under scrutiny.
Frequently Asked Questions: Prediction Market Loss Deductions
Can I deduct prediction market losses on my tax return?
Often, but not always. The result depends on the contract’s characterization, the taxpayer’s capacity, and how the position ended. Capital losses are subject to the capital-loss netting and carryforward rules. Ordinary character alone does not guarantee a deduction; for an individual, an otherwise allowable ordinary nonbusiness loss that is not from a sale or exchange is a miscellaneous itemized deduction currently disallowed under Section 67(h). Wagering losses are governed by the separate Section 165(d) limitations.
What is the 2026 gambling loss cap and how does it affect prediction market traders?
The One Big Beautiful Bill Act, effective for taxable years beginning after December 31, 2025, limits the wagering-loss deduction to 90 percent of wagering losses, still capped at wagering gains for the year. A trader with $200,000 in gross winnings and $200,000 in gross losses can only deduct $180,000 of losses against $200,000 of income, producing $20,000 of taxable phantom income despite no net economic gain. At a 37 percent marginal rate, the tax on that phantom income exceeds $7,000. This consequence arises under gambling treatment; whether other frameworks avoid it depends on the deduction-allowance analysis for the specific taxpayer.
Can I net prediction market gains and losses before reporting them?
Capital gains and losses are combined under the statutory capital-loss rules. No general contract-level or annual netting rule has been established for ordinary nonwagering prediction-market contracts; the result depends on the applicable transaction and instrument analysis. Under gambling treatment, the netting question is the unit-of-account question: wagering gains and losses must first be measured by an appropriate transaction or session unit under Section 61, and no published guidance defines that unit for continuous prediction-market trading. Notice 2015-21’s proposed safe harbor is limited to electronically tracked slot machine play and does not permit separate sessions to be netted against each other. Gross wagering gains are reported as income, and wagering losses are separately limited under Section 165(d). The absence of a defined unit creates a documentation and interpretation challenge specific to the wagering framework.
This article is provided by Camuso CPA for general informational purposes and does not constitute legal, tax, accounting, or investment advice. Tax laws and regulations are evolving rapidly and the information presented may not reflect current guidance. Reading this article does not create a CPA-client relationship. For advice on your specific situation, schedule a consultation with Camuso CPA.
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