I just finished downloading windows 7 setup for my vista. I chose custom installation because I'm upgrading to win7 professional from vista home premium, but soon after it asked me, "Where do you want to install Windows 7?" with a list of 3 types of harddrives: Disk 0 Partition 1 (type: OEM reserved), Disk 0 Partition 2 Recovery (D (type: Primary), and Disk 0 Partition 3 OS (C (type: System).
Which one should I choose to do a clean installation?
Note: this dell pc provides a way to change the system back to factory settings without any CD's, and I don't want to lose that option. Will upgrading to windows 7 lose that option?
The best thing to do might be to reformat the whole drive, repartition, do a reinstall and make your own recovery partition. The Dell recovery partition will only recover you back to whatever was installed when you got the computer (vista i guess).
"Note: this dell pc provides a way to change the system back to factory settings without any CD's, and I don't want to lose that option. Will upgrading to windows 7 lose that option?"
You should still be able to use the recovery partition by pressing the assigned key at startup, providing you don't delete or format it.
It would be a good idea to create a set of recovery disks first, before you format anything anyway. If your hard drive fails you will no longer be able to use the recovery partition.
Seeing as you want to keep that option, do what bobalazs said and format partition 3 and use that.