To be completely honest, having a smaller tank does not necessarily mean a smaller cost. My nano tends to cost me more as I need to do more frequent water changes, etc.
Anyways, I would use new sand and seed it with a cup or two of the sand from the tank you have now. Don't use all the sand out of your system that's up now, stirring it up too much can really release some nasty toxins and you don't want to add them to a new tank. I would definitely use your rock again, and as for the water, it doesn't make a difference. I would just do new water and let the tank stand for a few days with some of the rock from your current tank and make sure there are no spikes, since it sounds like you don't want to do a full cycle and run two tanks at once.