Finding this thread years later. Replying in case someone else, like me, is trying to figure this one out.
It looks like you can’t use the Delete Asset interface’s “Replace References” feature to replace a Material with a Material Instance. You can only select Materials. Likely it is the same in reverse; you can’t use it to replace a Material Instance with a Material.
I haven’t found a better method yet than manually replacing each Material with it’s correct Material Instance. It’s awful.