What Is Section 1256 For Prediction Market Traders?

The short version: if a contract is taxed under Section 1256, 60% of the profit gets the lower long-term capital gains rate and 40% gets the higher short-term rate, regardless of how long the trader held it. That split applies to every contract on a CFTC-regulated exchange. The IRS has not formally confirmed that prediction market event contracts on Kalshi, Polymarket, or the sportsbook platforms qualify, but the case is strong enough that practitioner-led filers regularly use it. This post explains what Section 1256 is, why it matters for prediction market traders, and what to do about it.

I'm Chris Herbst, Managing Director at CountDeFi, a global crypto tax reporting firm specializing in complex cryptocurrency and DeFi reconciliations. This is the short answer to a question I get every January from prediction market traders trying to figure out why their tax bill is so much higher than it needs to be.

What Is Section 1256 In Plain Terms?

Section 1256 is the part of the US tax code that gives certain regulated contracts a more favorable tax treatment than ordinary trades, by splitting gains and losses 60% long-term and 40% short-term regardless of holding period. The rule was written for traders in futures and options on regulated US exchanges, and it applies to "Section 1256 contracts" as defined in IRC Section 1256(b).

The 60/40 Split, In Real Numbers

The 60/40 rule is the heart of Section 1256, and it matters because long-term capital gains are taxed at materially lower federal rates than short-term gains:

• A trader in the 32% bracket pays 32% on short-term gains and roughly 15% on long-term gains.
• Under Section 1256, 60% of every gain is taxed at the long-term rate and 40% at the short-term rate, even if the contract was held for 15 minutes.
• On a $50,000 prediction market gain, the difference between full short-term treatment and the Section 1256 blended rate is roughly $5,000 in federal tax.

The Section 1256 rule applies in both directions, which means it also applies to losses, and a Section 1256 loss splits the same 60/40 way.

The Mark-To-Market Rule

The second piece of Section 1256 is the mark-to-market rule, which says any open contracts at year-end are treated as if they were sold on December 31 at fair market value. The gain or loss on the unrealized position gets recognized in the current tax year. For prediction market traders, this matters because a contract bought in November that has not resolved by December 31 is still a Section 1256 reporting event if the framework applies.

Why Does Section 1256 Matter For Prediction Market Traders?

Section 1256 matters for prediction market traders because most prediction market contracts are short-term by nature, and short-term gains are otherwise taxed at the highest ordinary income rates. Without Section 1256, a high-volume Kalshi or Polymarket trader pays full ordinary income tax on every win. With Section 1256, the same trader gets the 60/40 blended rate on the same profits.

The Case For Section 1256 On CFTC-Regulated Prediction Markets

The Section 1256 case for prediction market activity rests on a specific reference in the statute. IRC Section 1256(b)(2)(B) covers contracts traded on a CFTC-regulated Designated Contract Market, and prediction market event contracts on Kalshi, Crypto.com OG, post-relaunch Polymarket, PredictIt, ProphetX, and Novig all trade on DCMs. By extension, prediction markets routed through a DCM in the background also have a Section 1256 case, which captures Robinhood Event Contracts, DraftKings Predictions, FanDuel Predicts, and Coinbase Prediction Markets. The platform-level overview lives in my prediction markets tax guide.

Why The IRS Has Not Confirmed Section 1256 For Event Contracts

The IRS has not issued a Revenue Ruling, a Private Letter Ruling, or a formal FAQ confirming Section 1256 treatment for prediction market event contracts. The silence is not accidental, because the underlying regulatory question, whether prediction market event contracts are federally regulated swaps or state-regulated gambling, is still moving through the federal courts. The Third Circuit ruled for federal preemption on April 6, 2026 in a 2-1 divided panel decision, and the Ninth Circuit is widely expected to rule the other way. Until the regulatory question settles, the IRS classification question stays open.

The Practical Position For 2026 Filers

The practical Section 1256 position for prediction market traders in 2026 is to file Form 6781, document the platform's CFTC DCM status, and reference Section 1256(b)(2)(B) in the working papers. Some practitioners pair the Section 1256 position with a disclosure form (Form 8275) to flag the classification choice to the IRS and reduce penalty exposure in an examination. The IRS has not rejected Section 1256 on prediction market activity, and the position is materially stronger than ordinary capital asset treatment on the rate side, but it is a practitioner judgment call that needs documentation.

What Are The Risks Of Filing Under Section 1256?

The risks of filing prediction market activity under Section 1256 are that the IRS has not confirmed the position, the Form 6781 filing itself signals the classification choice to the IRS, and the regulatory framework underneath is genuinely contested.

The Examination Risk

The Section 1256 examination risk for prediction market traders is real but manageable. The IRS has not rejected Section 1256 on event contracts, and filers who document the position carefully have not faced a meaningful audit pattern as of mid-2026. The risk increases if the trader files Section 1256 without supporting documentation, applies it inconsistently across platforms, or uses it on prediction market activity routed through a platform that is not actually on a CFTC-regulated DCM. The broader audit picture lives in my guide on surviving an IRS crypto audit.

The Misclassification Risk On Sports Event Contracts

The Section 1256 misclassification risk is highest on sports event contracts specifically. Sports event contracts are the most contested category in the regulatory fight, with several state courts having found that sports event contracts are gambling under state law. A prediction market trader who files heavy sports event contract activity under Section 1256 should be ready to defend against an IRS argument that the activity is gambling rather than a regulated derivative. Modeling the gambling-track tax bill alongside the Section 1256 tax bill is part of the work, particularly under the OBBBA 90% gambling loss cap.

Do You Need Help With A Section 1256 Filing Decision?

The Section 1256 filing decision is one of the most consequential prediction market tax choices a US trader will make in 2026, and the difference between a documented Section 1256 position and an undocumented one can be the difference between a clean filing and a notice letter.

CountDeFi Is Your Prediction Markets Tax Experts

The Section 1256 question on prediction market activity is genuinely contested, and the practitioner positions that hold up on examination are documented thoroughly, applied consistently per platform, and supported by trade-by-trade reconciliation. We are not just accountants at CountDeFi, we are data scientists who work exclusively on crypto, which is what it takes to reconstruct a prediction market history that supports a Section 1256 filing. Headquartered in Oregon, we have worked with more than 1,000 clients globally since 2017. If you are filing prediction market activity for the first time, or amending a prior year that may have been filed under the wrong framework, book a free call with one of CountDeFi's IRS crypto tax specialists.

Chris Herbst is the founder of CountDeFi, a crypto tax specialist with degrees in both accounting and computer science, and a registered Tax Professional (GTP, CIBA). This article is for educational purposes only and does not constitute tax, legal, or investment advice. Consult a qualified tax professional for guidance specific to your situation.

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