Stephen,
A PS2 or PS3 engine is neer in neutral when under DCS control.
Regardless, if you're trying to do a Factory Reset with a DCS signal present, you can safely do it any time the engine is not moving, whether or not it's been started up under DCS. However, a Factory Reset is not a transformer reset. A transformer Reset is a Feature Reset.
A Factory Reset may only be done from DCS. To do a Factory Reset for a PS2 or PS3 engine, you must first ensure that the engine is on a powered track that's connected to a TIU channel. Then, press:
Menu/Advanced/Reset Engine/Factory Reset, select the engine and press the thumbwheel twice.
Note that a Factory Reset will also remove the engine from the DCS Remote, and that you'll have to re-add before you can once again operate it under DCS.
Why are you desiring to do a Factory Reset?
This and a whole lot more is all in "The DCS O Gauge Companion 2nd Edition", now available for purchase as an eBook or a printed book from MTH's web store site! Click on the link below to go to MTH's web page for the book!