1) The steering wheel can skip to next/previous track. On the HU you can press "M" (manual) then use << and >> to skip to next/previous directory of MP3s; not sure if the steering wheel buttons do the same when "manual" is active.
2) My MP3s are 192K fixed bit rate and they work. I don't know if VBR works - I guess you can experiment eventually. I did read recently of someone that the player could not read their CDR; I suspect some brands / colors are less readable than others.
3) There is never any display or folder / directory / track / etc. Only two numbers - one which counts up/down to indicate a directory and one which counts up/down to indicate a track. I don't know how the numbering works if you nest directories inside other directories.
4) There are many threads about iPod connection - some interfaces will allow steering wheel control, some won't.
The Dension ICElink plus has some limitations (and in the past some issues too) but *may* be able to provide limited track display info on an '05 head unit.
The BMW/MINI official solution gives no displays (it even suppresses the iPod display I think) but does give steering wheel control provided you set up the playlists in the way required.
The AUX input solution is cheap but has no control - just audio input.
There are probably others. A search would be sensible!
4a) Yes, I know a couple of people that have painted their iPod.
Pics of Randolphs BRG on my weblog. Again a search would help you.