No, but you will be taxed on the portion of those funds not used towards the purchase of the replacement property on the Section 1031 exchange. Let's look at the following example: Mary Lou, our taxpayer, originally purchased an investment piece of real estate for $450,000. A few years later she decides to sell the property for the sum of $750,000. On paper she has a $300,000 profit ($750,000 less $450,000 = $300,000). Since she had no loans on the property, she will receive $750,000 in cash at closing. Mary Lou discusses her financial situation with her CPA. The CPA points out that if she purchases a replacement property of equal value or more and uses all of the sales proceeds towards the purchase of the replacement property, she will defer paying any taxes on her $300,000 profit.
That sounds great---but Mary Lou wants to purchase a replacement property of $795,000 and at the same time use $50,000 of the proceeds to purchase a chevy corvette. She can still purchase the replacement property, it's price is more than what she sold for, but she will have to borrow around $95,000 to close on the purchase, if she still wants to also obtain the corvette. Additionally, she will be able to conclude a Section 1031 exchange on all of the proceeds except the $50,000, on which she will be taxed. The reason of course is that she didn't use all of her funds from the sale of the relinquished property towards the purchase of the replacement property. She concludes a partial exchange by having to pay taxes on the $50,000 and defers paying any other taxes on the other proceeds. Still not a bad result. This is a real case and as was said in the old "Dragnet" series, "the names have been withheld in order to protect the innocent".
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