QUESTION: My daughter plans to move to, Washington, and I plan to move to Atlanta on retirement. I have a house there with an 8 percent mortgage.

I want to sell my Washington home, which is mortgage-free, to my daughter for approximately $100,000. I would be eligible for the once-in-a-lifetime senior citizen exemption.

My daughter's current income would permit her to secure a $35,000 first mortgage, plus pay the annual maintenance expenses of heat, light, water, telephone, taxes, etc.

I would take back a $65,000 second mortgage at, for example, 6 percent per annum, with the provision that she would start paying the interest and principal after five years. If she sold the house, the entire $65,000 mortgage would become due and payable.

I also want an agreement with the first mortgage holder that in the event of a default, I would have the first option to assume that mortgage.

It is practically impossible for young people to get a "grubstake" in their own homes these high-interest-rate days. Is the arrangement I have described legal and feasible?

ANSWER: Not only is the arrangement legal and feasible, but it also makes a good deal of sense.

You indicate that your daughter could probably qualify for a $35,000 first mortgage. You might want to assist her by adding your name to the mortgage, so as to permit her to borrow a little bit more. After all, the more she borrows, the more you will get from the sale, and as you have indicated, that money is tax-free because you are eligible for the once-in-a-lifetime senior citizen exemption. (Alternatively, you might consider refinancing your Atlanta house and taking back a $100,000 first mortgage from your daughter.)

Some mortgage lenders may balk at the second trust arrangement. However, because you are not asking the first trust lender to put a lot of money into the deal, I suspect that you will be able to find a mortgage lender who is willing to go along with this approach. You should make it quite clear to the first mortgage holder that you will be the second trust holder, and that if there is a default on the first trust, you should be notified immediately.

I recommend that on the day settlement takes place, you send a letter, certified, return-receipt-requested, to the first mortgage lender, spelling out your involvement as a second trust holder and asking for a signed statement that you will be informed in the event of any default. You also should make the arrangements before settlement, so that the first trust lender will permit you to assume the mortgage if your daughter defaults.

There is one problem with the terms of your second deed of trust, however. You have indicated that you will take back a mortgage and charge your daughter 6 percent per annum, but that she will not have to start paying interest and principal until five years from now. Unfortunately, you may be hit with what is commonly known in the tax trade as "phantom income."

The Internal Revenue Service says that in such family transactions, if the interest rate is less than 7 percent, the IRS will treat that transaction as if you were getting a 7 percent rate of return. This is called "imputed interest."

More significantly, even though you will not receive this money from your daughter on a year-to-year basis, the IRS may treat the transaction as if you were in fact receiving the income. Accordingly, even if your daughter is not paying you, you will have to pay the IRS as if you had received the interest, calculated at 7 percent per annum. Thus, the "phantom income" concept.

I suggest that you restructure the second trust arrangement and require that your daughter actually pay you interest only, at least 7 percent per year, for the next five years. This way, your daughter will be able to take some tax deductions and you will not have the "phantom income" problem.

If your daughter needs additional funds, I suggest that you contact your tax adviser to consider whether it makes sense to make a gift to your daughter each year. Under the tax laws, you are permitted to give up to $10,000 each year, and these funds are tax-free to your daughter. If you file a joint tax return with your wife, you can give a gift of up to $20,000 each year without having to pay gift taxes. Under this approach, you will not have the "phantom income" problem while, at the same time, your daughter will be able to live comfortably in her house.

Your creative approach to this problem should be considered by many parents.