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you can upgrade with a blank microSD card, but copy any files you have on to your computer beforehand so they don't get wiped when it formats the card. so no, you do not need to copy anything to make it work, but you probably ought to copy anything you want to keep and then move it back (I think maybe the updater does this automatically, but I can't swear to it.)
the official firmware is gonna split your internal card down the middle (4MB for apps and 4 you can access).
I know kewlguy over on slatedroid was playing around with setting up custom partitions (or capping how much was off limits for apps). no idea what the status of that is.
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