>> bread itself still is too dry

Do you mean the crumb is too dry, or the crust is too hard, or both? 

• If crumb is too dry, try adding more liquid, more sugar, more fat to the dough. 
• If crust is too hard/thick, try messing with the baking times & temperatures, and increase fat content in dough. 

Potato flakes will definitely help keep it moister & fluffier. Add them back in. 

By my estimates, your dough might be too wet:

• 2.5c flour = ~313g
• 1c skim milk = ~236g

That makes for ~75% hydration, which is probably too wet if you want a light, fluffy, sandwich style bread. Try reducing the liquid to reach 55-60% hydration instead. Also check the kneaded dough before it rises, it should look smooth and satiny; if not, it might be under-kneaded. The key to really light fluffy bread is intensive kneading. Check out txfarmer's posts to see what I'm talking about. 

One more thing: try using an all-purpose flour instead of bread flour, that will help give you a less chewy, softer texture. 

Take a picture of your next loaf (crust and crumb) and post it, easier to provide feedback that way. 

A few general things to try:

1. Have you gone through the directions that came with the bread machine to see if there's a "troubleshooting" or "common problems" section? If so, it may suggest a solution.
2. Have you tried different cycles and/or loaf sizes (the exact choices are different for every bread machine). Often there's a table in the back of the directions that tells you exactly how long the "bake" phase is for each dough type setting. If your bread machine lets you select dough amount, how about setting it for "1-1/2 pounds" but only putting in ingredients for "1 pound"?
3. Have you called the manufacturer's help line? Generally bread machines will prominently display a phone number. And generally the people on the other end of the phone (even though possibly more brusque than you'd wish) are pretty helpful.

King Arthur Bread flour is a little strong; so avoid it in the bread machine. If you're using another bread flour try substituting in a half cup of AP flour.

Jim

Get a new recipe.

I have a Zo bread maker, my white bread was the same way.  Found this very simple recipe that works great...I have learned some times less is more

-One cup warm water (less then 110 degrees)

-two tablespoons white sugar

-two teaspoons active yeast (I use a active quick dry yeast)

     Let stand for ten minutes (don't need it for quick yeast but my bread comes out better when I do this step...don't know why..lol)

-one quarter cup veg. oil (I use crisco)

-three cups bread flour (I use King Arthur unbleached bread flour)

-one teaspoons salt

Thats it... six ingredients very simple.  Since I use a quick yeast I set to quick bread and light crust, takes 2 hours and 18 minutes.  Full baking cycle would be 3 hours and 45 minutes, loaf was slightly bigger but basically the same, so I just use the quick setting now when ever I want a white bread. 

I have also made a raisin bread with this recipe by adding one teaspoon of cinnamon and 1 cup raisins, I add the raisins well before the add cycle about 3 or 4 minutes into the kneading cycle, it just mixes better, some times the dough looks a little sticky I threw in a pinch of flour to fix it up, so watch your dough doing raisin bread.  Probably need to adjust the recipe for the added ingredients, but since I have no idea what I am doing, I always end up winging it.  Still comes out great...lol...have no idea why.