If you have $1k, pretty much all of us will encourage you to use it all, as long as you can comfortably handle the expenditure. You are quite a ways from the point of diminishing returns, but that's not to say you can't build a very pleasant system either.
First of all, forget the whole receiver upscaling thing. Not worth it with your budget.
Think about it... which is going to process video better? A $1,000-$2,000 video display, or a $500 receiver (which means 7 amps, preamp, processor, eq/rc, radio, etc)?
I generally like shady's 1/3 proportion, if this system could never be touched, changed, improved, upgraded.
If I could upgrade anywhere in the relatively near future, I'd spend as little as possible on the receiver, to get the best speakers and sub I could.
Processors/receivers outdate relatively quickly. Not so with speakers and sub.
You could make a *small* receiver compromise, and maybe find a used HDMI receiver that simply handles mch PCM. Then have player decode.
However, at this budget, I would even consider a *larger* compromise, and find a $100 garage sale DD/DTS optical receiver, so that I could get the things that really count: speakers 'n sub.