Why the deferred gain is so much less than the recognized gain

[Stanley She]

I bought a rental property 7 years ago for $198000. Last year, I sold it for $400000. For the sake of simple discussion, let me ignore all purchasing and selling costs. So, my gain is 202000. Within one month of the sales, I purchased a like-type property at $265000. I would think that all my gain of 202000 is ALL used up in the new purchase... not only that, I have further invested more in order to purchase the new property.  By that, my recognized gain should be 0, and all 202000 should be deferred gain. 

But, the tax software is telling me: my recognized gain is 400000 - 265000 = 135000! The deferred gain is only 65000. 

Which is correct, mine or the software? 

Anyone can enlighten me? Much appreciated in advance.

Stanley

[Dave Foster]

@Stanley She, 

@Stanley She, The requirement to fully defer tax in a 1031 exchange is to purchase at least as much as your net sale. And to use all of the net proceeds from your sale in the purchase or purchases of the new property.

When you purchase less than you sold the IRS views that difference as taking profit out. It's easy to understand why you would want to say that you were taking out your original capital and leaving the profit in the 1031. But the IRS says you are taking profit out and leaving your original capital in.

So it is true that the difference between your net sale ($400K ish) and your actual replacement purchase ($265K ish) would be viewed by the IRS (and your software) as taking profit.