Considering the drubbing the financial markets have taken, now is a good time to consider reducing your tax bill by tax swapping.

To tax swap, you sell a bond for less than you paid for it and purchase another bond you hope will perform better. You create a "paper loss" that may be applied against ordinary income or any capital gains that you have incurred.

Once you have established your loss, the reinvestment of the proceeds offers you an opportunity to strengthen your bond holdings.

You can upgrade the quality of your portfolio, you can increase your income by buying a higher coupon or you can consolidate holdings. If you think interest rates are going to fall, you can lengthen maturities and buy discount bonds in anticipation of capital appreciation. If you think rates are going to rise and want to protect your principal, you could buy a bond with a high coupon and a shorter maturity.

Here are a few basics to keep in mind:

Don't forget commissions on the bond deals -- make sure they won't erase your tax savings.

Bond swaps may be conducted at any time. Swaps for losses may be executed as late as the last business day of the year to offset the year's taxes.

At this point, long-term capital gains on investments held more than six months do not enjoy preferential tax treatment. Both short-term and long-term capital gains are taxed as ordinary income.

Capital gains and losses must be netted out against each other before any capital losses can be applied to reduce ordinary income.

Up to $3,000 of ordinary income may be offset by capital losses each year, for single or joint returns. If you are married but filing a separate return, only $1,500 is permitted for each individual.

Net long-term or short-term capital losses may be carried forward indefinitely, but only after you have taken your $3,000 ordinary income deduction.

You can't sell a bond, take the loss and immediately buy back the same issue. The new bond must have a different issuer, coupon or maturity. If you do want to buy the same issue, you must wait 30 days. If a substantially similar security has been purchased within 30 days before or after the sale, the Internal Revenue Service could disallow the loss.

On Tuesday, the Resolution Funding Corp. is scheduled to offer a 30-year bond, and on Wednesday the Treasury is scheduled to offer a seven-year note. Both will be available in $1,000 minimums and should return 9.05 percent and 8.55 percent, respectively.