Okay so it's quite simple really. Take your spritesheet from entities, draw the item (on a new layer) that you want the player to wear on the spritesheet for every frame, then delete the character, flatten the image and make sure everywhere around the item is transparent.
You've now paperdolled that item, save it in paperdoll as #.png (keep it sequential, 1, 2, 3, 4, etc)
When you use the editor to make an item, you can specify a paperdoll image and the image will render on top of your character in the game when they equip this item.
Not yet, this will likely have to be something you add in yourself when the source is released.
I also want to make a game that uses a turn-based battle system (except mine takes place on a board, like Chess, and with multiple pieces) we just have to wait at the moment.
Kem's post in How To Paperdoll? was marked as the answer