Rentals are typically considered passive and thus subject to passive loss limitations. Rental income is generally not reported on Sch. C. In your situation the husband/wife schedule C's are offsetting so it is as if there is no rental income/expense.
To set-up an S corp I typically recommend using a lawyer to do the incorporation paperwork, but a site like www.legalzoom.com could also walk you through it. A corp or an LLC would work. Once the entity is created, a Form 2553 would need to be filed to "elect" to be taxed as an S corporation.
Yes, S corps can (and usually always) have employees. Owners of an S corp are actually required to take a reasonable salary.
Yes, the husband could still contribute to the SEP IRA but there may be more favorable retirement options. I typically work with a trusted pension expert on the set-up of the retirement plan because the rules are complex.
The property management should be reported on Sch. C but the rental activity is what seems to me should be reported on Sch. E. Keep in mind I am an outsider to the whole situation and this is a general response. But generally, rental income and expenses go on Sch. E not C. The result is lower SE tax if there is income, but potential limited losses if there are losses (due to the passive loss limitations).
For a full detailed review of the situation it is advisable to have all of the tax returns reviewed by a CPA and have a lengthy discussion before making any drastic changes. I'm not trying to sound like I'm backing out of an answer, but this forum is more for general tax questions as opposed to an assessment of a tax situation.
I hope I have helped and thank you again for using this service.