Yeah, the way to get the best sound is to go from CD to what ever codec you choose, the best ones being lossless or higher quality. The drm free stuff is better, i don't know first hand how much better but it should be better. Most stuff you will get off limewire will not be much higher than mp3's 160 kbps.
On the topic of creating a second library hold option when you open iTunes, this will cause itunes to open a window leaving you with three options. It will ask if you want to cancel, open existing library or create a new library. When you choose create new library it will ask you where you want it located. From there it will act as a normal itunes library, you wont know the difference. You will find that itunes will naturally attempt to open the last library that was open. When you want to switch between which library itunes opens hold the option button when you launch itunes again.