I get asked this question all the time. I have had clients want to use the proceeds for everything from paying off charge card bills, going on vacations, to buying themselves a Porsche automobile.
The answer to this question was delineated in one of the four rules of what we in the Qualified Intermediary industry call the “Napkin Rule”. The part of the rule discussing use of proceeds says: “Thou shalt use all of the proceeds from the sale of the relinquished property towards the purchase of the replacement property.” OK–so what if you don’t use all of the proceeds towards the purchase of the replacement property–will that invalidate your entire Section 1031 Tax Deferred Exchange? The Answer is NO it won’t–but you will be taxed on the portion of the proceeds that you kept and did not use towards the purchase of the replacement property–the rest of the proceeds that were used towards the purchase of the replacement property would not be taxed at this time as a result of Section 1031. This type of transaction is called a “partial” exchange.