You've used the correct tense, but I would say "handed down."

It's correct, but there is a better way of writing it. "handed out" sounds as though you are giving it with your hand to other people in order to maximize reach (and thus maximize the amount of people that know about it). If I were to rewrite it, I'd say, "This legend was passed down in our family from generation to generation." This way it doesn't have to be "given" in a physical sense, but rather is told or written down / recorded in some way and then taken from one place to another via that medium (in this case person to person, and the medium being spoken). ALTERNATIVELY (this is important), you can also say that it was "handed down." The emphasis, however, still lies in a physical "giving." Nonetheless, that is still correct.

Like the others said, it should be either "hand down" or "passed down". So 1. This legend is handed down from generation to generation in our family. 2. This legend is passed down from generation to generation in our family. If you say "is handed" and "is passed", it means that at some point in the future it will be handed down again to others who are not born yet. If you say "was handed" and "was passed", you are talking about the past strictly.