My question is about 1031 exchange and whether I can get rid of the mortgages from my life once and for all, by investing only with the equity I got? Looks like this great idea is not possible.
The question is: Can the replacement property be around 400K, or is it that it must be worth 850K, and I must end up with a new 450K mortgage?
The key element of a 1031 is that you are replacing the property with on at least as expensive. Any cash pulled out creates tax issues.
I believe it is doable the amount not used in the exchange is subject to taxation based on this description:
A 1031 Exchange allows a taxpayer to defer 100% of their capital gain tax liability. To do this, the exchanger must buy new Replacement Property equal to or greater than in value to the property sold and reinvest all of the proceeds from the sale of their old property.
But what happens if a taxpayer desires to purchase property lower in value or takes a portion of the cash from the closing of the sale and only invests a portion of their proceeds towards a 1031 Exchange? The good news is that these transactions still qualify for tax deferral under Section 1031 of the Tax Code. They simply become “partial” 1031 Exchanges where the taxpayer has a partially tax deferred transaction rather than deferring all of their taxes.
The portion of the exchange proceeds not reinvested is called “boot” and is subject to capital gains and depreciation recapture taxes.
taken from this site: https://www.ipx1031.com/partial-exchange/
