Q.We are in our sixties and are contemplating selling our large home and adding a "granny flat" of 1,000 square feet to a home owned by our son and his wife. They are amenable. We would finance the construction because the equity in our present home would be more than enough to cover the cost. What is the best way to proceed to protect everyone's interest, and what should be covered in the agreement our attorney will draw up?

A.You are wise to consider an agreement with your son and his wife. Even in the best families, problems arise, and it is always best to draw up a written agreement now while you are still talking to each other. Should you move in and have problems, it may be too late to resolve your differences if you have no legal, written document.

First, let's look at the tax issues. On the assumption that you and your wife have been living in your house for three out of the past five years, because you are in your sixties, you are eligible for the once-in-a-lifetime exemption of up to $125,000, of any profits you earned on your house.

When you fill out your income tax return the year after the sale, you will complete a form (number 2119, entitled "Sale of Your Home") and this will be made part of your income tax return.

However, if you have made a profit of more than $125,000, this additional gain will be taxed at ordinary income tax rates. It is possible that this additional gain will kick you into the highest tax bracket, which currently for married individuals filing joint returns can be as high as 33 percent on any taxable income between $74,850 and $155,320. You would be wise to discuss these issues with your tax advisers before you sell your house. If the profit that you have made is significant, you might want to consider hanging on to the house, renting it out and leaving it as an inheritance for your children. They would then obtain the "stepped-up" basis that currently under tax laws would save them from having to pay the tax on the profit that you may have to pay.

You also have indicated that you would be financing the construction of the addition. What tax bracket are you in? Are there any advantages in having your son and his wife obtain financing so that they can take the interest deductions, and could take credit for the capital improvement to the house?

For example, you could lend your son the money and he would pay you interest, just as if you were a bank. While this interest would be income to you, your son may be able to deduct the interest, since this would be a home-improvement loan. Again, this has to be carefully structured by your tax advisers.

You also may want to consider giving a gift to your son and his wife, and they then could construct the addition.

As I have indicated, the tax consequences must be explored -- before you make the determination of how to proceed.

The partnership issue is also complex. There are many questions that should be asked before you proceed with the arrangement.

What happens if you find that you and your wife cannot live in your son's home? Who owns the addition? Will there be any rent charged to you for living in the addition, and if so, how much? Who will pay any increase in utility costs and real estate taxes created by this addition? What happens if you decide to move out?

Additionally, do you have any other children? Are you properly protecting their interests after your death? The last thing you want is to have your other children fighting over the ownership of that addition.

It must be kept in mind that you have taken perhaps your largest asset -- your house -- and in effect given it to your son. While this may be your intention, there is an old expression that "when there is a will, there are relatives."

Lawyers are often accused of being too pessimistic. I see my role as attempting to highlight some of the possible "horrible hypotheticals" that can -- and often do -- come up.

We all hope that the relationships between parent and child will be smooth. However, this is not always the case and you are smart to consider these issues now.

Discuss these matters with your attorney, and suggest that your son and daughter-in-law retain their own counsel to resolve any questions.

In my opinion, an ounce of preventive law is cheaper than a pound of cure.

Benny L. Kass is a Washington attorney. For a free copy of the booklet "A Guide to Settlement on Your New Home," send a self-addressed stamped envelope to Benny L. Kass, Suite 1100, 1050 17th St. NW, Washington, D.C. 20036. Readers may also send questions to him at that address.