Best thing you can be is a music fan, so right on, dude.

1. If it's a fairly cheap dvd/surround sound system, then it likely is keeping some of the quality of the music from you.
There's nothing inherently wrong with it being surround sound, and there can be great surround systems. For me, though, my 2 channel sounds way better than my neighbor's 5.1 system, because the components are way better, and are made for music. My neighbor has the advantage of occasionally hearing the effect of, like, a plane flying from front to rear. I have the advantage of hearing music that is more beautiful and true.

2. Get a 2 channel system? yes, if you want to. Or upgrade your current system, piece by piece. Some people run their systems 2 channel and go back to 5.1 when they watch movies.

3. All cd players convert signals to analog, and the analog signal then goes to the amp/receiver, and that gets sent to the speakers, which are driven analog. (There are exceptions; some cd players send digital to the amp/reciever, but that then gets converted to analog which gets sent to the speakers).
Yes, with a $1,000 system, you will get great sound out of cds! "I have around 800 cds, so the thought of replacing them with vinyl is a little daunting." NO NEED to replace them, treasure and listen to them! Also, probably impossible to replace those with vinyl anyway - some recordings are released on both CD and vinyl, but most are released CD only.
For vinyl records, get a turntable and add it to your system. (you will need an amp or receiver that has turntable input).
"I am looking at getting our basement fixed up to be a rec room, with tv, couches, my guitars and my music collection and a new stereo." NICE!
"I'm looking at spending around $1,000 for a system for now, and gradually upgrading in the following years." COOL.
Others will probably suggest specific components, so I'll let them have a say. Happy listening.

yes, generally so. Some formerly great "stereo" stores around here have gone completely "home theater", and they presume that all customers want are $5000 tv's, with $60 speakers to hang on the wall around them.

here's a friendly website retailer that I've bought things from with good results:
www.audioadvisor.com

musicdirect.com and acousticsounds.com are good too, I've heard, but I don't have personal experience w 'em.

for example - aa has athena LS500 full range speakers, $300/pair; marantz 5001 cd player $300; cambridge 340a integrated amplifier $330. That's $930. plenty of other combinations can be arranged.
Later add a nice turntable, Rega P1, with cartridge included, $350.

(add a "phono stage" ((phono pre-preamp)) to run the turntable into - some receivers/amps, like the cambridge above, don't have them built in. That might add $100, to get the cambridge brand plug-in to the amp above)

Quote:
yes, generally so. Some formerly great "stereo" stores around here have gone completely "home theater", and they presume that all customers want are $5000 tv's, with $60 speakers to hang on the wall around them.

here's a friendly website retailer that I've bought things from with good results:
www.audioadvisor.com

musicdirect.com and acousticsounds.com are good too, I've heard, but I don't have personal experience w 'em.

Good advice from BillB- I've dealt with Audio Advisor and Music Direct with good results. They offer lots of service and support before/after the sale. The closest audio shops to me are 100 miles away and don't carry an extensive line, so the above mentioned have been very helpful.