How do I make my iphoto Library a System Photo Library?

A System Photos Library will only work well, if it is on a compatible drive. Perhaps you know this already, but setting up iCloud Photos is very time consuming for a large library, and it will be less cumbersome, if you get it right on the first attempt - soothes advice is just in case you should have overlooked something.

If you are keeping your huge 1.2 TB System Photos Library on an external drive, check, if it is having a compatible file system format. The disk needs to have a wired connection, and it must not have been used for Time Machine backups. A good test to see if your external drive is compatible is to try to set the "Ignore ownership on this volume" flag. If it is not possible to enable this flag, your drive is not compatible. See: Move your Photos library to save space on your Mac - Apple Support

The system Photos Library needs always to be available to the background processes, while you are signed into your user account; keep it connected at all times, even if you are currently not working with Photos. Otherwise Photos may lose the connection to its System Library and you would have to repeat the iCloud syncing over and over again. With a library as large as yours you may expect the the initial upload to iCloud Photos to take several weeks, and you may not be seeing any progress in the status bar for very long periods. Let it run, that is normal. If you toggle iCloud Syncing on and off, it will just start over and take even longer.

Do you really need a Photos Library as large as yours? It is a bit large for iCloud Photos, even with a 2TB storage plan. You may encounter problems when you have to upload your Photos Library again, if you ever have to turn off iCloud Photos and then enable it again. Photos will only let you turn on iCloud Photos for a library, if you have enough free cloud storage to hold all media from this library in addition to the items already in iCloud. So you should always have enough free storage to upload the complete library a second time. Photos will not really create duplicates, when you upload the library again - it will be merged into the existing library, but Photos is not checking for duplicates when it is estimating the storage that is needed. It will just use the worst case estimate, based on the assumption that all photos in the library are different from the ones already in iCloud.

It would be much safer to reduce the size of your iCloud Photos library to get it well below 1TB. Then you can keep 1TB of iCloud storage free, or use it only for items, the can be easily moved to a different storage, if you need to start the iCloud syncing again, for example, if you had to move your Photos Library to a different drive.

Your assumptions are right on.

léonie is warning you about some possible problems with having a large Library. Having a cat (follow me here) that's the same size as its cat carrier is a problem, because the cat needs to turn around. (Here's the point:) A Photos Library also needs turn-around room. As it makes copies for transferring and other operations, it takes up way more space than the static size of the Library might suggest. Usually, you would like to have as much empty storage as the size of the Library package, itself.

Another problem with a large library is that some operations become very slow. For many operations, this slowing is not linear--that is, twice the Library may take way more than twice the time for some functions. Obviously scanning for faces, categories, and other such properties takes longer, as well as searching for those things. But even editing and displaying pictures may take longer. Updating the Library when the OS changes will take longer.

If somehow the large Library develops a problem, the cause may be harder to find and the fix harder to work. A single corrupt file, for instance, may cause the Library to stall, and make fixing it hard.

Backing up a large Library may become so time consuming that you are tempted to do it less often.

And if something awful happens to a large library, it happens to all your pictures.

What many of us do is divide our pictures up among different Libraries. Photos lets you have lots of different Libraries, but only one can be the System Library--that's the one that synchronizes with iCloud. You can switch between Library my just double clicking on the next Library package, or you can option-click on the Photos app and it will give a list of all the Libraries you can switch to.

So, for instance, I have libraries for different trips and special events-- these don't change often (only when I go back to them to sort and edit them) so they don't need to be in constant sync with my other devices.

But I also have a Favorites & Recents Library, my System Library, where I put the Favorites from the other Libraries that I really want to see on my phone or iPad. And that's where the new pictures from my phone are synced to. Then I periodically transfer those pictures from my System Library to a Libraries that are more archival.

My System Library is small enough to reside on my MacAir, so I don't have to worry that unplugging could possibly cause problems. I use the app PowerPhotos ($30) to make copying and switching and searching through libraries easier.

I think this is the sort of stuff that léonie was getting at...

Yes, that's it.