Prediction market arbitrage generates real, taxable income — and in 2026, both the IRS and international tax authorities are paying closer attention to prediction market activity than ever before. Before you scale up your arbitrage strategy, here's exactly what you need to know about reporting and minimising your tax liability.
Is prediction market arbitrage taxable?
Yes. In the United States, profits from prediction market trading are taxable income. Whether your gains are treated as ordinary income or capital gains depends on the platform, the asset type, and how long you hold the position.
The key distinction for arbitrageurs: unlike directional traders who may hold positions for months, arbitrage trades are typically closed within days or weeks of the event resolution. This matters significantly for your tax bracket.
Kalshi: the most straightforward tax picture
Kalshi is a CFTC-regulated Designated Contract Market (DCM). US users with significant trading activity receive a 1099-B form from Kalshi at tax time, just like you would from a stock broker. Kalshi reports your proceeds and cost basis directly to the IRS.
Kalshi event contracts are likely treated as Section 1256 contracts under US tax law. Section 1256 contracts have a unique 60/40 tax treatment: 60% of gains are taxed as long-term capital gains (regardless of holding period) and 40% as short-term. This is generally more favourable than pure short-term treatment. However, Kalshi's regulatory status is still evolving — consult a tax professional for your specific situation.
Polymarket: your responsibility
Polymarket is a decentralised, blockchain-based exchange. It does not issue 1099s. You are entirely responsible for tracking and reporting your own activity. Every USDC payout from a resolved contract is a taxable event. Your basis is what you paid for the YES or NO token. Your gain is the payout minus the basis.
Because Polymarket settles in USDC on Polygon, some tax software treats each settlement as a crypto-to-crypto swap rather than a direct cash equivalent — which may affect how gains are categorised. Specialised crypto tax software (Koinly, TaxBit, Crypto.com Tax) can import Polygon transaction history to calculate your basis and gains automatically.
Short-term vs long-term treatment
Most arbitrage trades close within the same day or within a few weeks of execution (at event resolution). These are almost always short-term gains, taxed as ordinary income at your marginal rate. If you're in the 22% or higher bracket, this is a meaningful cost. Factor it into your return expectations: a 2% gross edge with a 22% tax rate reduces your after-tax return to approximately 1.56%.
Record-keeping essentials
For every arbitrage trade, you need to track: the event name, platform, entry price, number of contracts, exit price (settlement), gross profit, fees paid, and settlement date. Arbitrage Agent exports a CSV of all executed trades from the dashboard — use this as your primary record. Supplement with your Kalshi trade history and Polygon transaction exports from Polymarket.
Wash sale rules: do they apply?
The wash sale rule (which disallows a loss if you buy a substantially identical security within 30 days) technically applies only to stocks and securities under current IRS rules, not to prediction market contracts. However, the IRS has been expanding its guidance — check with a tax professional before assuming wash sale rules don't apply to your situation.
Quarterly estimated taxes
If you expect to owe more than $1,000 in taxes from prediction market trading, you may need to pay quarterly estimated taxes to avoid underpayment penalties. This is especially relevant for active arbitrageurs with significant monthly P&L.
Non-US traders
Tax treatment varies significantly by country. In the UK, prediction market profits may be classified as gambling winnings (tax-free for individuals) or trading income (taxable), depending on the regularity and intent. In Australia, similar distinctions apply. In most EU jurisdictions, trading income is taxable. Always verify current rules in your jurisdiction — this is not tax advice.
Practical recommendations
- Use Arbitrage Agent's CSV export at the end of each month for record-keeping
- Download your Kalshi trade history quarterly
- Export Polygon transaction data from a block explorer for Polymarket activity
- Consult a CPA familiar with prediction markets or financial derivatives
- Pay quarterly estimated taxes if your monthly P&L is significant
- Factor your effective tax rate into your minimum edge threshold — what looks like a 1.5% edge may be closer to 1.2% after-tax
This is not tax advice. Tax rules vary by jurisdiction and change frequently. Consult a qualified tax professional for your specific situation.