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@Mel7777 wrote:

They only received the funds for the difference between the gain ($550K-$165K) - $240K.  The cash received was $145K.  

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No, the client received $310k ($550 sold, $240 bought).  Some of that may have been forwarded to the mortgage company to pay off the mortgage, but the client received $310.

The program is correct and that is all taxable.  There was no point in the client doing the 1031 exchange, and wasting money paying the third-party intermediary.

1031 Exchanges are generally for 'upgrading' to a higher cost property.  Going down results in some or all of it being taxable.

Sorry for the bad news.