The simple answer to your question is yes, the distribution from the 401K is a taxable event and will be reported to you on Form 1099-R and subject to your normal income tax rates. If you are under age 59 1/2, it will also be subject to a 10% penalty for early withdrawal. As you did not mention who was occupying the townhouse, any mortgage interest and property taxes may be reported as an itemized deduction on Schedule A of your 1040 or if a rental, the income and expenses would be reported on Schedule E with the basis of the townhouse being subject to depreciation.
