1031 Help - new property financed with a mortgage

[Avrohom Roth]

Client Sells a property (which was owned by his LLC #1). LLC #1 then takes the proceeds and distributes it to LLC#2 which is fully owned by LLC#1. LLC#2 uses the funds to purchase a property a complete the 1031 exchange.

An qualified intermediary has been involved and all is documented properly.

Here's where it gets confusing.

When LLC#1 sold the property it had a deferred gain of $1,000,000 of the sale of a property for $2,000,000.

LLC#1 did not send the whole $1,000,000 to LLC#2. It sent $500,000. LLC#2 then used the $500,000, together with mortgage to purchase a new property for $2.5m, this way completing the 1031 exchange.

ON the books of LLC#1 I have a deferred gain of $1M. HOw am I reducing that when the exchange is complete?

Right now I have it as no deferred gain and a negative investment in LLC#2 for $500,000 ($500,000 actually invested - $1,000,000 deferred gain = -$500,000).

Is this correct? can anyone shed some guidance?

Or, I guess another way to ask this question is...... if you purchase a new property for more than you sold the old property, but you do not use the cash to purchase a new property, you go out and get financing for the new proeprty, is that a problem?