1031 Exchange for a Salon Suites or Small-Bay Retail Building

Suites are rooms in a building, so the building exchanges whether you call the payments rent or license fees

Salon suite operators often sign stylists to short license agreements rather than leases, and owners ask whether that makes the property a business instead of real estate. For the exchange it does not matter: a building used in your trade or business qualifies just as a rental does, and Reg. section 1.1031(a)-3 treats a license to use or occupy space in a building, in the nature of a leasehold, as an interest in real property.

The same regulation lists walls, partitions, doors, wiring, plumbing systems and HVAC as structural components, so the demising walls, sinks plumbed into each suite, suite lighting and the extra electrical service go with the building. Styling chairs, shampoo stations on stands, dryers, mirrors on stands and lobby furniture are personal property.

The regulation also says a license to operate a business is not real property. If your suites run under a salon-suite franchise, the franchise agreement is a section 197 intangible that is taxed when sold, and any price a buyer pays for the brand, the booking system or the tenant pipeline is business value outside the exchange.

Suite build-outs are qualified improvement property, and bonus on them is ordinary income on a cash sale

Interior improvements to a nonresidential building made after the building was first placed in service are qualified improvement property under section 168(e)(6), a 15-year class eligible for bonus depreciation, which Public Law 119-21 restored to 100% for property acquired after January 19, 2025. Converting a retail box into 20 suites is mostly that kind of work.

Qualified improvement property is still section 1250 property, and section 1250 treats depreciation above straight-line as ordinary income on a sale. In an exchange, section 1250(d)(4) limits that ordinary income to the gain you recognize, provided the replacement includes enough section 1250 property, which a building or a DST that owns buildings does.

Hypothetical: you bought a retail building in 2018 for $1,200,000, took about $200,000 of straight-line depreciation, and spent $400,000 in 2025 on suite build-outs that you fully expensed. Your adjusted basis is about $1,000,000; a 2026 sale at $2,300,000 for the real estate is a $1,300,000 gain, most of the build-out amount is ordinary recapture on a cash sale, and a complete exchange defers all of it. Run your own numbers with your CPA.

Many small tenants mean steady turnover, and that is what the next buyer prices

Stylists, nail technicians and small retailers are the other-services and small-retail sector, where turnover is normal. The Bureau of Labor Statistics establishment survival table for other services shows 60.0% of establishments that opened in the year ended March 2020 still operating five years later, and 42.1% of the 2015 cohort operating after ten years.

A buyer of a 20-suite building is buying 20 short agreements, a vacancy history, deposits and the work of re-filling suites. Expect requests for a rent roll with start dates, a 24-month occupancy history, collections, the cost of turning a suite, and whatever marketing and booking systems you use to keep the building full.

The services you provide also matter while you own it. Under Reg. section 1.1402(a)-4, services rendered primarily for the occupant's convenience beyond those customary for renting space, the regulation's example is maid service, can make the income self-employment income rather than rent. Laundry, product supply and front-desk booking are worth reviewing with your CPA before you set the sale price on that income.

Who buys these buildings: operators who want the business and investors who want the leases

An operator or franchisee will pay for the building, the furniture and the occupancy you built, and will want the allocation to show it; that puts value in personal property and goodwill that you cannot exchange. An investor will buy the real estate with the suite agreements in place and leave the business to an operator under a master lease.

If you run the suites yourself, a sale of building and business together is an applicable asset acquisition under section 1060, reported by both parties on Form 8594. Negotiate the allocation in the contract, assign the real-estate portion to your intermediary, and take the business proceeds directly.

A small-bay retail center without a suite program sells as ordinary multi-tenant retail; the retail strip center page covers co-tenancy, CAM reconciliations and anchor issues for that buyer.

Replacing management with passive ownership

Most sellers of suite buildings want fewer phone calls. A traditional DST removes management entirely, but Rev. Rul. 2004-86 bars the trustee from entering new leases or renegotiating existing ones except in a tenant's bankruptcy or insolvency, so you trade control for a fixed structure whose tenant credit is set at purchase.

A single net-leased building through a direct title security keeps title in your LLC with one tenant paying taxes, insurance and maintenance. The tired landlord guide compares those paths for owners leaving active management, and a cash-out DST is the tool when the building carries a large loan you need to replace.

Buying salon suites or small-bay retail as replacement property: underwrite the turnover, not the face rent

If you are moving into this property type, the rent roll is the asset. Ask for every suite or bay agreement, start and end dates, deposits, collections for 24 months, the number of move-outs per year and the cost and time to re-let a suite; a building that is full today but turns suites over every year or two needs a leasing engine to stay full.

Decide who owns the furniture before you identify. If the seller includes chairs, dryers and lobby furniture, that personal property is not like-kind and exchange money spent on it is taxable; Reg. section 1.1031(k)-1 only disregards incidental personal property up to 15% of the real estate's value for identification purposes.

Price the management you are taking on. If you will hire an operator, get the management agreement terms before day 45 and underwrite the property net of that fee; if you will run it yourself, your time is the fee. The three-property rule lets you name a passive backup alongside the suite building.