Question(s) about what could happen to my iPod Touch...

So I have just inherited my sister's launch iPod Touch, as she is receiving a gen 2 from her boyfriend in the very near future. I have a couple questions about what I need to do with it and the consequences of said actions:
1. How do I go about registering the Touch to my own Apple account? She has her own Apple/iTunes account (she also has a gen 2 Nano and a gen 2 Shuffle), and I want to be able to sync it with my own account. I realize that the songs and videos will be lost in the transition, but that's irrelevant to me.
2. Since this is a launch Touch, it came with ver. 1.0 OS software. Since then, she has paid for and installed ver. 2.2 (or whatever is latest prior to 3.0). In regards to my first question, will the Touch revert to ver. 1.0, and I will have to be forced to re-purchase the OS update in order to get the apps store, new features, etc?
Thanks for your time and patience.

So this is what popped up when I tried to sync the Touch:
"The iPod is synched with another iTunes account...what would you like to do?"
1. "Erase & Sync" replaces the contents of this iPod with the contents of this iTunes library (this worries me, since it doesn't specify what particular contents i.e. software updates).
2. "Transfer Purchases" copies iTunes Store purchases this computer is authorized to play from this iPod to this iTunes library (so, do I need my sister's ID and password to confirm I am able to use her bought data? If so, will this let me use all her apps, etc?)

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