Like Rishi and Reagan, I cannot recommend overwriting your DEV system with PRD data. The solution Reagan talks about (from the Note) should be considered as a last resort, but if you can get another system in your landscape for testing, whether as a sandbox or a QAS system, that will be far superior.
Remember, you aren't just testing how well your changes work. You are also testing how well transporting those changes works. You can only do that if you have a system to transport the changes to.
As for maintaining your development and change history, this becomes invaluable if you ever need to revert a change to undo something, and also for reconciling your modifications with updates brought by support packs and upgrades (i.e., SPAU/SPDD). Without a good version and change history, upgrades become riskier if you've made any modifications to standard components in your system (even from applying notes via SNOTE).
I understand that in these days of tight budgets it may be difficult to justify buying another piece of hardware, but you will have to do this anyway if you want to do a parallel landscape during the project. I would rate getting a QAS system in place as higher in priority than a sandbox, and higher in priority than a temporary parallel landscape. Those things are very helpful as well, but I think that QAS should come first.
If you then are not able to also have a parallel landscape, you could consider limiting the impact of the upgrade by splitting it into two distinct phases. Phase I would be a technical-only upgrade, with no new customizing and no enabling of new functionality; in this phase your testing effort would be focused on making sure existing business processes continue to work as before. In Phase II you could start to activate new business functions and introduce desired functional changes. By doing this you can keep the timeframe of the technical upgrade shorter, and thus reduce the exposure of not having a parallel production support landscape.
Then take the money saved by not building that parallel landscape and use it to buy a server for QAS.