4 smart ways to reduce your tax bill

Dump your losers and cash in some winners. Moves you can make now to cushion the blow to your portfolio

By Janet Morrissey, contributor

NEW YORK (Fortune) -- We spoke to several leading financial advisers about the strategies they were recommending their clients adopt to cut their taxes now and in the future.

Harvest your stock market losses

"We have been aggressively harvesting tax losses for our clients over the last year or two, and of course the market environment has assisted us with that," says Gregg Fisher, president of financial advisory firm Gerstein Fisher.

"Those losses can be used to offset capital gains in the future, and if you think capital gains rates might be higher in the future, those losses become even more valuable," he says.

And for clients who still like the battered stock they just sold, no problem. IRS rules allow an investor to buy the asset back after 31 days.

Cash in some winners

There's also a tax strategy for those with gains in their portfolio.

A number of advisers are urging their more affluent clients to sell some of those appreciated assets in order to lock in the gain, and to pay the capital gains tax while it's only 15%, before it rises to 20% in 2011.

These investors can also buy back the same shares after 31 days if they still want to own the stock.

Invest in municipal bonds

Many advisers are also recommending that clients put a bigger chunk of their cash into tax-free municipal bonds.

Although many states are facing severe financial difficulties because of the recession, "We like munis right now because even during the Great Depression the default rate was less than 4%, and we're not in a Great Depression," says Mark Brown, a managing partner at Brown & Tedstrom, a financial planning and advisory firm.

"In a normal recession, less than one-tenth of 1% has been the historical default rate." He adds that their prices have fallen over the past six months, making them even more attractive.

Divide and conquer

Even as tax rates rise, you'll probably be paying less on capital gains than on ordinary income.

Sean Cunniff, a research director in TowerGroup's brokerage and wealth management service, is recommending that investors take advantage of that gap by favoring fixed-income investments (which pay interest that is taxed as ordinary income) in your tax-deferred accounts and putting equity investments with big potential long-term capital gains into taxable accounts. To top of page

 
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