I like the idea. I also know that most players will dislike it, because their metsl goes away and that they cant selecr xXitemXx in reactions.
If you want to manipulate item wear, and force players to pay more attention to uniforms and weapons, you must also give them options to save them. A reaction to repair xXarmorXx to armor and sharpen xXweaponXx to weapon would be ideal, but I assume that the AI would have issues with that even if implemented correctly, because the reagents (armor and weapons) are worn by your units.
The bad thoughts for your smith from lost Masterpieces is a problem as well.
My suggestion:
Item quality affects wear-rate. The higher the quality, the slower the wear. Masterpieces get no wear at all, giving players the option to only use their best items without losing them.
Item material affects wear. Bronze wears faster than iron, iron faster then steel and so on. Adamantine has no wear.
Weapons and Armor should only wear from use, if that is possible to implement.
A way to make clothing not wear out would be nice. Metal clothing should wear slower, masterpieces not at all, the same idea. It would be only fair to give the option to save some of the clothing, if you take away some of the armor/weapons.
Artefacts shouldnt wear out.
A reaction to target xXitemXx to either destroy, recycle or repair should be given.
Worn away metal items should leave a "itemcorpse" if you want to call it that. A chunk of that metal type that can be molten down into bars again. Broken swords dont just disappear, its the item that breaks, not the material. A "reforge" reaction could be nice as well: Take broken steel sword, fuel and one steel bar to reforge it, after its broken.
I would absolutely love this for MDF and add it as an option, which probably would be enabled by default. Good luck.