Last Updated on February 23, 2026 by Patrick Camuso, CPA
Prediction markets now operate within formal regulatory infrastructure and, in certain instances, under direct CFTC supervision. Platforms such as Kalshi function as Designated Contract Markets and list standardized event-based contracts tied to defined political, economic, and other factual outcomes. As trading volume has increased on regulated exchanges, federal income tax classification questions have become unavoidable.
A central issue is whether these contracts qualify for treatment under §1256 of the Internal Revenue Code. For a broader discussion of how U.S. tax law applies to prediction market contracts outside of §1256, including realization, character, and reporting mechanics, see our comprehensive guide to prediction market taxes explained.
Section 1256 is a narrowly constructed statutory regime that applies only to specifically enumerated instruments, including regulated futures contracts and certain exchange-traded options. Event-based prediction contracts are not expressly included within those categories. Eligibility turns on statutory interpretation and definitional analysis.
This discussion about section 1256 and prediction markets reviews the operative language of §1256, explains how the statute functions and evaluates the structural considerations relevant to prediction market contracts, particularly those traded on CFTC-regulated platforms such as Kalshi.
The purpose is analytical rather than conclusory. No position is asserted here that §1256 does or does not apply in any particular case. Instead, the analysis identifies the statutory requirements that must be satisfied before such treatment can be responsibly claimed and defended.
What Section 1256 Actually Does
Section 1256 establishes a specialized tax regime for a defined set of financial contracts. Where a contract qualifies under the statute, several consequences follow.
First, gain or loss is subject to the statutory 60/40 rule. Sixty percent of the net gain or loss is treated as long-term capital gain or loss, and forty percent is treated as short-term capital gain or loss, regardless of the actual holding period. Second, contracts are marked to market at the close of each taxable year. Unrealized gains and losses are treated as if realized on the last business day of the year, and the contract is treated as reacquired at fair market value on that date. Third, reporting occurs on Form 6781, which aggregates §1256 contract gains and losses before flowing amounts to Schedule D.
For taxpayers in higher marginal brackets, the blended 60/40 treatment can produce a materially different tax outcome compared to full ordinary income treatment or entirely short-term capital gain treatment.
These rate mechanics explain why §1256 is frequently raised in discussions involving prediction market contracts. The potential benefit is clear. Whether the statutory requirements are satisfied is a separate and more technical question.
Section 1256 Is a Statutory Override
The critical structural point is that §1256 functions as a statutory override.
Under normal tax rules, when a taxpayer disposes of a contractual right, the analysis begins with §1001, which determines whether gain or loss has been realized and how it is measured. Character is then determined under §1221, which asks whether the asset is a capital asset in the taxpayer’s hands. That framework applies by default.
Section 1256 replaces that default analysis for a limited set of specifically defined contracts. When it applies, it changes both timing and character. Contracts are marked to market at year-end, and gains and losses are subject to the statutory 60/40 treatment, regardless of actual holding period.
Because §1256 overrides the baseline regime, it applies only if the instrument fits within the categories Congress expressly identified. Economic similarity, policy arguments, or regulatory status do not expand the statute. If the contract does not meet the definitions in §1256, the general rules under §§1001 and 1221 continue to govern.
The Enumerated Categories Under §1256(b)
Section 1256(b)(1) defines what qualifies as a “Section 1256 contract.” The statute limits that designation to a specific set of instruments:
- Regulated futures contracts
- Foreign currency contracts
- Nonequity options
- Dealer equity options
- Dealer securities futures contracts
Prediction market contracts are not named directly. As a result, qualification under §1256 does not arise by analogy or economic similarity. It depends on whether the contract can be shown to fall within one of these enumerated categories under the statutory definitions.
If it cannot, §1256 treatment does not apply, and the analysis returns to the general tax framework.
Regulated Futures Contracts
Section 1256(g)(1) defines a regulated futures contract as a contract that is traded on or subject to the rules of a qualified board or exchange and is required to be marked to market daily. Both elements must be satisfied. Exchange status alone does not establish qualification.
A “qualified board or exchange” generally includes a national securities exchange registered with the SEC, a Designated Contract Market regulated by the CFTC, and certain qualifying foreign boards of trade. Kalshi operates as a CFTC-regulated Designated Contract Market. From an exchange-status perspective, this element may be satisfied for contracts traded on that platform. However, satisfying the exchange requirement does not, by itself, establish §1256 eligibility. The statutory definition also requires that the contract be required to be marked to market daily.
Traditional regulated futures contracts are subject to daily variation margin, marked to market at the clearing level, and settled through clearinghouses that adjust positions on a daily basis. Prediction market contracts may have fluctuating prices as event probabilities change and may be centrally cleared, but price movement alone does not satisfy the statutory daily mark-to-market requirement. The relevant inquiry is whether the contract is structurally required to be marked to market daily within the meaning of §1256(g), not whether its value changes over time. Exchange oversight and economic resemblance are related considerations, but they are not interchangeable.
An additional structural issue concerns the nature of the underlying reference. Historically, regulated futures contracts have involved commodities, financial instruments, indices, interest rates, or currency values. Prediction market contracts instead resolve based on discrete factual outcomes, such as whether a candidate wins an election, whether CPI exceeds a stated threshold, or whether legislation passes. The question, therefore, is whether a binary event outcome constitutes the type of underlying contemplated by §1256(g). The statute does not expressly address event-based contracts. Any determination regarding RFC status must therefore rest on interpretation of the statutory language rather than direct textual inclusion.
Nonequity Options
Section 1256 also applies to certain nonequity options. In general terms, a nonequity option is an option that is not an equity option and that is traded on a qualified board or exchange. Like regulated futures contracts, qualification depends on fitting within the statutory definition, not on functional similarity alone.
The interpretive question is whether prediction market contracts can be characterized as “options” within the meaning of §1256. Prediction contracts often share structural features associated with option-like instruments. They typically have a fixed maximum payout, such as one dollar per contract. The purchase price reflects a market-implied probability of the outcome, and settlement is binary at resolution. These features resemble certain exchange-traded financial products.
However, prediction market contracts are not necessarily options on securities, commodities, indices, or other traditional financial underlyings. Instead, they are contingent contracts tied to discrete factual outcomes. The statutory question is therefore narrower and more technical. Did Congress intend the term “option” in §1256 to include contracts written on purely factual events rather than financial instruments or measurable market indices?
The statute does not expressly answer this question. It does not define “option” in a way that directly addresses event-based contracts, nor does it explicitly include or exclude binary contracts tied to non-financial outcomes. As a result, classification depends on statutory interpretation rather than textual clarity.
Binary Structure Alone Is Not Determinative
A common argument is that because some exchange-traded binary options qualify for §1256 treatment, prediction market contracts should qualify as well.
A binary payout, by itself, does not determine eligibility under §1256. Some financial binary options may qualify because they are tied to recognized financial underlyings, traded on regulated exchanges and structured within derivatives categories specifically contemplated by the statute. In those cases, the binary feature is only one component of a contract that already fits within §1256’s defined framework.
Prediction market contracts are also binary in form, but the subject matter they reference often differs from traditional financial derivatives. The statutory question is whether the contract falls within one of the specific categories Congress identified in §1256.
CFTC Regulation: Necessary But Not Sufficient
Kalshi’s status as a CFTC-regulated Designated Contract Market is frequently cited as a decisive factor in the §1256 analysis. We examine Kalshi’s reporting mechanics, settlement structure, and federal tax implications in greater detail in our dedicated analysis of Kalshi tax reporting.
CFTC oversight may satisfy the “qualified board or exchange” element required under certain §1256 categories. It does not, by itself, establish that the instrument being traded fits within the statutory definitions of a regulated futures contract, nonequity option, or other enumerated contract type.
Federal income tax treatment is governed by the Internal Revenue Code, not the Commodity Exchange Act. While regulatory classification can inform the analysis, it does not expand the categories Congress specifically identified in §1256. Regulatory status alone does not convert an instrument into a §1256 contract if the statutory requirements are not otherwise satisfied.
Legislative Silence and IRS Guidance
At present, there is no IRS guidance directly addressing the treatment of prediction market contracts under §1256. No revenue rulings or formal pronouncements clarify whether event-based contracts qualify as regulated futures contracts or nonequity options for purposes of the statute. Likewise, §1256 has not been amended to expressly include event-based contracts within its enumerated categories.
In the absence of explicit inclusion, any position asserting §1256 treatment must rest on careful statutory interpretation rather than assumption or analogy.
Baseline Tax Framework Without §1256
If §1256 does not apply, prediction market contracts are analyzed under the general tax framework that governs the disposition of property and contractual rights. This baseline analysis mirrors the approach taken for emerging financial instruments more broadly, including digital asset transactions where novel transactions require disciplined interpretation rather than assumption.
Under that baseline regime, §1001 determines whether gain or loss has been realized upon sale or settlement and how that gain or loss is measured. §1221 then determines whether the contract is a capital asset in the taxpayer’s hands, which in turn affects character.
Within this framework, gain or loss is generally realized when the contract is sold or settled. Character depends on whether the contract qualifies as a capital asset under §1221, subject to its exclusions. Holding period rules apply in the ordinary manner and may affect whether gain is short-term or long-term.
Section 1256 displaces this baseline analysis only if its statutory requirements are clearly satisfied. If those requirements are not met, the general realization and character rules continue to govern.
What Would Strengthen a §1256 Argument?
Several developments could materially strengthen a §1256 argument for prediction market contracts.
First, the IRS could issue formal guidance explicitly addressing event-based contracts and their treatment under §1256. A revenue ruling, notice, or other published interpretation would significantly narrow the interpretive gap.
Second, Congress could amend §1256 to expressly include event-based contracts within its enumerated categories. Because §1256 is a statutory override regime, legislative expansion would provide the most direct path to certainty.
Third, judicial interpretation could apply §1256 to event-based instruments in a way that clarifies how the statutory definitions operate in this context.
Absent one of these developments, qualification remains an interpretive question grounded in statutory construction rather than explicit inclusion.
Practical Observations
In practice, reporting approaches vary. Some practitioners default to ordinary income treatment in the absence of explicit guidance. Others analyze contracts under the general realization framework of §1001 and the capital asset rules of §1221. A smaller group evaluates whether §1256 treatment can be supported based on exchange status and structural arguments.This variation reflects the absence of authoritative guidance directly addressing event-based prediction market contracts. Where statutory language is not explicit and administrative interpretation is limited, reasonable professionals may reach different conclusions based on their anlaysis.
Taxpayers evaluating whether §1256 applies to their activity should ensure that any position taken aligns with their broader reporting framework. In practice, that often requires a full transaction-level reconstruction before characterization is even considered. Our approach to prediction market tax reporting focuses first on statutory qualification and documentation, then on defensible implementation across all contracts and tax years.
Section 1256 applies only to the specific contract categories Congress listed in the statute. It is a defined exception to the general tax rules, not a flexible standard that automatically extends to instruments that look similar.
Prediction market contracts are not expressly included in those categories. Whether a particular contract qualifies as a regulated futures contract or a nonequity option depends on how the statutory definitions apply to the structure of the instrument.
CFTC regulation may satisfy certain exchange-related requirements within §1256, but regulatory status alone does not determine tax treatment. The Internal Revenue Code controls the analysis.
Because there is no explicit IRS guidance or legislative amendment addressing event-based prediction contracts under §1256, the question remains unsettled. Taxpayers considering §1256 treatment should evaluate the statutory requirements carefully and ensure that any position taken is supported by the language of the Code and the facts of the contract.
Policy Implications: Why the §1256 Question Matters
The application of §1256 to prediction market contracts raises broader questions about how the Internal Revenue Code adapts to financial instruments that were not contemplated when the statute was drafted. Section 1256 was enacted to address specific categories of regulated derivatives, principally commodities futures and certain exchange-traded options, with the goal of standardizing character treatment, limiting timing manipulation, and creating uniform rules for exchange-cleared contracts.
Prediction markets operate within regulated exchange environments and may utilize clearing infrastructure comparable to traditional derivatives venues. However, many of these contracts resolve based on discrete factual outcomes rather than financial prices, rates, indices, or commodity values.
This raises three related policy considerations. If event-based contracts differ in underlying reference from traditional futures and options, it is necessary to determine whether Congress intended them to fall within the same regime. Differing tax treatment for instruments that may be economically similar but statutorily distinct can influence product design and capital allocation. When a statute does not directly address a developing market, reliance on inference can produce inconsistent reporting positions and uncertainty.
This dynamic reflects a recurring pattern in emerging financial markets in which regulatory frameworks evolve more rapidly than tax guidance. Prediction markets may operate under established CFTC structures, yet tax classification questions remain unsettled. Until Congress amends §1256 or the IRS issues formal guidance, application of the statute to event-based contracts depends on careful analysis of statutory definitions rather than analogy to traditional derivatives.
For policymakers, the open question is whether event-based contracts should remain subject to general realization and capital asset principles or be expressly incorporated into the §1256 regime. For taxpayers and advisors, the current framework requires disciplined evaluation of the statutory requirements before asserting specialized treatment. As trading volume expands, the demand for clarity is likely to increase, but under existing law the analysis remains one of statutory interpretation rather than presumption.
FAQs
Does Section 1256 automatically apply to Kalshi or other CFTC-regulated prediction markets?
No. CFTC regulation may satisfy the “qualified board or exchange” element relevant to certain §1256 categories, but it does not automatically determine federal income tax treatment. Section 1256 applies only if the contract itself fits within one of the enumerated statutory categories, such as a regulated futures contract or nonequity option. Regulatory status alone is not sufficient.
Are prediction market contracts considered regulated futures contracts under §1256?
Not automatically. To qualify as a regulated futures contract under §1256(g), a contract must be traded on a qualified board or exchange and be required to be marked to market daily. Even if exchange status is satisfied, questions remain regarding whether event-based contracts meet the statutory mark-to-market and underlying-instrument requirements. The statute does not expressly address binary event contracts.
Can prediction market contracts qualify as nonequity options for §1256 purposes?
Possibly, but the analysis is interpretive. While prediction contracts share certain structural features with options, such as fixed payout and binary resolution, they are not necessarily options on securities, commodities, or financial indices. Section 1256 does not explicitly clarify whether contracts based on discrete factual outcomes fall within the term “nonequity option,” leaving room for reasonable disagreement.
If §1256 does not apply, how are prediction market contracts taxed?
Absent §1256 qualification, prediction market contracts are generally analyzed under the standard tax framework. Gain or loss is measured under §1001 upon sale or settlement, and character is determined under §1221 based on whether the contract is a capital asset in the taxpayer’s hands. Holding period rules apply normally unless another statutory regime governs.
Is there IRS guidance confirming whether prediction markets qualify for §1256 treatment?
No. As of now, there are no IRS revenue rulings, notices, or formal guidance directly addressing whether event-based prediction market contracts qualify under §1256. There have also been no legislative amendments specifically adding such contracts to the statute. Any assertion of §1256 treatment must therefore rely on careful statutory interpretation rather than explicit inclusion.
