Yes you could pay yourself, lower the cost, reimburse yourself some of the down payment. 

You can recapture some of the 10-20% AND provide additional value to the client in the form of a lower overall price for the same rental. 

We would use hard money and close very quickly.

Two bedrooms in that size especially with a basement which probably has lower ceilings and not a lot of windows will look more like a prison cell/

Either one would be our primary residence, so down payment and closing costs are fairly the same.

I am getting ready to close on my first property - it's a duplex located in the Pilsen neighborhood of Chicago, and I will be renting out the first floor unit and occupying the second floor unit myself.

One issue of doing it within 401k, is what happens if you spend all your money from there, and then have unexpected expenses or lower ROI than expected. 

Maybe they have a lower percentage of owner-occupied units, insufficient contribution to reserves, or some lingering issues.

I own an escrow company in Irvine, CA and we can close your deal. 

Are you talking about someone who does all the deal sourcing, closing, and transaction management?