Based on what you are saying, number 2 is the most correct way to handle the rental income and expenses.
Basically, setting up the property as a straight rental is the way to go. Recapture of depreciation can be a pain but TurboTax makes it relatively easy. Just keep a record of your depreciation with your other home documents and add it in when you sell the property.
The link you had at the end was talking about a home rented for less than a year and then pulled out of the rental market. You would not be able to use the same method of avoiding depreciation for your home rented for more than a year.
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