I am developing an online multiplayer RPG in which if your character dies, you lose everything in your inventory. However, you do leave behind a corpse from which you (or anyone else) can loot your items from.

I have been doing some research on other games that implement this and discovered two incredibly popular ones:

Realm of the Mad God (http://en.wikipedia.org/wiki/Realm_of_the_Mad_God)

Runescape (http://runescape.wikia.com/wiki/Death)

So I suppose players are open to "item-perma death". To avoid making it too painful, I am going to make premium/paid or rare/legendary items safe from this. E.g. Like Runescape, you can pick 3 items to save from item-perma death.

What do you guys think about this? And what kind of pitfalls would you suggest I avoid?

i wouldn't recommend saving premium and/or legendary items, the premmy-thing would come very close to "selling power" and the legendary-rule would mean someone would reach a certain level where he/she can actually acquire legendary items first.
(although it could work if implemented differently:
legendary:just add "safe" items(on every level) that are less strong but cant be stolen
premium:well, it might work, you need income in some way anyway, a premium might for examplebe able to select one additional item that is safe or you could say "for premiums boots are always safe" and have boots never be overpowered but still be important enough that it's something you want to replace quickly after death)
selecting "x" items that are safe sounds like the best road to go though, you could implement various skills related to this, which is core to most RPG'd

I feel like losing all of your items when you die may frustrate users and they may stop playing your game at that point because they don't want to have to go through all the work of trying to obtain their items again. I also feel like this would cause powerful characters to continually become more powerful as they can loot whatever good items they want from other users and keep them or sell them for gold.

What reasoning do you have for such a system? It sounds like a more realistic way to handle dying in a game but realism in a game shouldn't control gameplay mechanics. Your top priority should be to make the game fun.

i wouldn't recommend saving premium and/or legendary items, the premmy-thing would come very close to "selling power" and the legendary-rule would mean someone would reach a certain level where he/she can actually acquire legendary items first.

True. I will probably not sell premium items or have ultra rare/legendary loot...to avoid frustrating players who loses them.

So you lose every item, but you get to keep the character, did i understand correct? if yes, i do not think i would like it. maybe if you die you can lose some random items from your inventory that are not equipped or something like that... just a suggestion from a fan of perma-death games

Well technically your character dies lol. But you get to create a new character at the same level with the exact same abilities so essentially you only lose the items.

I used to play a MMORPG that had a mechanic similar to this but implemented in a different way called Argentum Online. Every player had a bank account where they could deposit items/money, This account was only accessed from a NPC in most cities. So you would go out to loot, if killed all the items you where carrying would be tossed on the floor but anything deposited on the bank would remain (you only had access to the banks items when alive and tacking to the banks NPC). They had a revival system where you had to walk to town and talk to a priest (your player transformed into a ghost when dead) and you wold come back to life(with no items though). There was also a revive magic that other players could use to revive you but since you dropped everything on death you usually lost most of your gear in the meantime. Some items couldn’t be lost though, mostly faction amour (this was obtained though a quest and couldn’t be bought so getting another one was impossible) but even the best faction amour was mid tier.

The bank account had no limit on money deposited but had a limit on items (it was an odd item cap, You could have up to 30 item stacks of 10000. this allowed to have tons of low value items like potions but restricted the expensive ones since having 10000 of any equipment was insanely expensive).