How does taxation work in this case if we both form a single person LLC? 

@Joshua Callanan In Maryland, I go to the Department of Taxation website and search the legal entity search.

Income from passive investments would be sheltered from taxation in a 401k.

As far as I know, there's not been major changes to the tax laws on this since.There's several situations that leads to taxation of the boot.

@Li TolentinoThe matter should be discussed with your CPA.An IRA has exposure to taxation in two situations. 

The ROI differential of putting $40K into a $100K property as opposed to putting $100K all cash into the same property will be significant, and that few hundred dollars of taxation plus the cost of a CPA to do the IRA tax return will be a small reduction in the benefits of using leverage.

The only way I have been able to find them is by using the Maryland Department of Assessment and Taxation's Real Property Search:  http://sdat.dat.maryland.gov/RealProperty/Pages/de.... 

@Patrick HallAs @Dmitriy Fomichenko accurately stated -rental income in an Ira or 401k is exempt from federal taxation.

C corporations often cause you to experience double taxation.

Taxation status and company legal formation are two different things.For a disregarded entity you will have no tax filing.