The City of Alexandria has proposed a settlement of its 7-year-old dispute with the federal government over ownership of the city's historic waterfront. The proposal, outlined in a letter hand-delivered this week to Interior Secretary Cecil D. Andrus and U.S. Attorney General Benjamin Civiletti, includes a significant retreat by the city on the crucial element of building height limitations.

In the letters, Mayor Charles E. Beatley Jr. proposed on behalf of the City Council that a federal suit claiming title to the waterfront be dropped in exchange for the city accepting federal demands for a 30-foot height limit for new construction on the six parcels the city owns along the waterfront. In the past, city planners have supported a 50-foot height limitation.

The city also offered to keep its land in open space-recreational uses. In the past, planners have said waterfront-related uses, including marinas and restaurants, could be built there.

Federal officials could not be reached for comment.

The proposal marks the first time the city has offered to end its connection to the suit, filed by the Justice Department in 1973 against the city and private landowners.

Beatley, who presided over council meetings in the early 1970s when high rises were approved, had made resolution of the suit one of his primary tasks for this term in office.

"Federal officials have said they want to sign this thing," said council member Donald C. Casey, an attorney who helped to draft the proposal. "We've just got to get them to act before Jan. 20 (when the Reagan administration takes office)."

Casey said the inevitable bureaucratic paper-shuffling of a new administration could delay settlement of the suit for as long as a year. That delay could end up costing the city as much as $100,000 to prepare for the suit.

The city owns more than half of the land involved in the suit. The remaining parcels are owned by private companies, who are expected to keep this land in industrial use or set up new commercial of residential developments. The private owners are not affected by the city proposal, although Casey said he hoped a settlement would encourage the other owners to settle also.

In the past several months, federal officials have shown a willingness to stop legal action against waterfront property owners if they would agree to put permanent conditions on their deeds, limiting the height of present buildings to their present sizes. Most of the structures involved are 30 to 50 feet high.

If an accord is reached, city and Interior Department officials would have to decide who would run the parks along the water's edge and who would pay for their maintenance.