Q. We are selling the home that we used as our principal residence for 3 1/2 of the last five years.

After paying the sales commission, we will receive $206,000. The house cost us $80,000, and we have spent $20,000 on improvements. We may be moving to an area in which the top-of-the-line houses cost about $90,000.

Is there any way we can avoid paying tax on the $106,000 gain?

A. First, you should be delighted that you have made a substantial profit on the sale of your house. In many parts of the country, people have been lucky to break even and in many instances have even sold their houses at a loss.

You indicate that you purchased the property for $80,000 and spent about $20,000 in improvements. That means that your adjusted basis is $100,000. Tax is paid on profit, which oversimplified is the difference between the adjusted purchase price, or basis, and the adjusted selling price. Thus, it is in your best interest to try to raise the basis as much as legally possible, so that your profit will be less -- and thus you have to pay less tax.

Go back to your settlement sheet when you first purchased the property. There were a number of items that were added, such as recording and transfer taxes, attorneys' fees, title search and title Insurance. Unless you already have taken advantage of these expenses, you should be able to add these items to your adjusted basis. It is possible that if you used the property for rental, your accountant might have already used up these additional items.

On the selling end, you are entitled to deduct certain expenses related to the sale for purposes of reducing your sales price, and also your profit.

For example, if you pay a real estate broker's commission, legal fees, transfer or recording taxes, or even some or all of the buyer's points, there are selling expenses that reduce the adjusted sales price of your property.

Additionally, expenses to fix up a residence for sale are deducted from the amount realized if those expenses are not capital expenses for permanent improvements that you have already added to the basis of the property, and are paid within 30 days after the residence was sold. In other words, these so-called "fix-up" costs are those that you spend to make your property more attractive to prospective buyers.

There is another way of avoiding the tax if you are 55 years old on the date of the sale of your residence. To qualify for the once-in-a-lifetime exemption of $125,000 of the gain, you also must have owned and used the property as your principal residence for at least three of the five years ending on the date of the sale. If you are over 55, in your case you would not have to pay any money, since your gain is less than $125,000.

There is one additional way of deferring the tax. If you sell your house and take back financing, you may be able to take advantage of the installment sale method of taxation.

Under this approach, if at least one payment is received in a tax year after the year of sale, under the installment method, gain from an installment sale is pro rated and realized over the years in which the payments are received. In other words, as the funds come in every year, you have to pay a percentage of your gain on a yearly basis. Keep in mind that you are merely deferring the tax, not avoiding it.

Finally, if you have not yet sold your house, you should talk with your accountant immediately to determine whether it would be better for you to sell this year or early in 1991. Congress recently enacted amendments to the tax laws and the timing of your sale may determine your tax bracket. This is a new law, and if you have the opportunity to defer the sale until 1991, you should explore the tax ramifications immediately with your tax advisers.

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.