Downstairs. You want to be by a bathroom and a kitchen with a baby and eventually a toddler. I have crammed a king bed in the smallest of rooms. Even if you breastfeed, you will want to be close to a kitchen for something to drink in the middle of the night! Put a baby gate by the bottom of the stairs. The upstairs will make wonderful guest rooms, office, ect.

Yes, downstairs for all of the reasons given.

Downstairs. The 2nd floor bedrooms will be great for office and walk in closet. The closets are too small in many houses, if you have an extra room, that's prefect for it.

I think if you can afford it, a bath on the 2nd floor would be money well spent, not just for your own convenience but for resale value. I would never have bought the house you did without a bath on the 2nd floor. Think about it...

Well, I wouldn't have bought that house for that reason, either--but there's obviously a market for that type of house! OP simply asked about arrangement of rooms--not about spending $$$ for something. :)

It is a possible that this was a 2 bedroom and 2 bath house with an attic. Then the attic was converted to bedrooms. That is why the master bath is in the smallest room. It is a perfectly good plan when you have older kids. They can most certainly go up and down the stairs for the bathroom. It would even be fine for the adults upstairs after the kids are older. Right now though, the owners are going to be tired enough with a new baby. They will need to reduce effort needed! That is why I suggested using the downstairs and keeping the rooms up for guests. I like the idea of one room up for a walk in closet also.

Stairs and newborns scare me. I'd stay on the first level and make the upstairs the adult getaway area.

Just to offer another perspective....I would consider using the upstairs as your actual bedrooms. It doesn't sound like huge house, and if you use the downstairs rooms as bedrooms, the upstairs could become space that you rarely use. It might be nice to create a playroom and office space on the first floor. Not ideal to go downstairs to the bathroom, but certainly not awful, and to me it would be worth it to have a more functional, fully-utilized space.

A big consideration for me would be the bathroom right off the nursery. Time goes by quickly, all of a sudden you have a toddler, who knows when the day is that he can suddenly reach the doorknob and get into the bathroom. Very dangerous.

I know you don't want to do anything major, but does the layout lend itself to closing off the bathroom door to the little downstairs bedroom and creating one to the largest bedroom?

Also, keep in mind that whatever you decide, it's not impossible to switch it around if things aren't working. No one likes to lug a bunch of furniture up and down stairs, but it IS possible!

Downstairs. You don't want to be going down and up the stairs groggy in the middle of the night carrying a baby when you go for a bottle or have to cleanup vommit or holding a crying baby when YOU have to use a bathroom.