Oooh, I could write forever on this one :) Ask David, it's true.
Do it. That's the short form.
Playing "build the ideal Targa car" is a lot of fun. Step one, as in any racing series, is to get the regulations and read them. Note that they may change in 2010, the current regulations are 2006-09.
Now check out page 2 of this PDF. That shows the handicapping. Since that particular stage is pretty short, the difference is only 21 seconds from fastest (Open) to slowest (2 SS Small). But the times are determined from a multiplier. The Open Class cars have to run 25% faster than the slowest ones, and I know I've seen the factors published somewhere. This is important if you want to win, as your placement is determined by the number of penalties you pick up. The newer your car, the faster you have to go to be competitive. Your E34 will be in either 8 SS Large or 8 MS Large depending on modification level.
A friend and I are currently arguing the merits of an old Escort with a BDA, a 1961 Lotus Super Seven with a fully built crossflow and a Lotus Elan Sprint as Targa cars. Meanwhile, I think dropping an LS1 into my Targa Miata would make for a fantastic car but would pop me into the big leagues against factory rally teams and the Group B Quattro.
The car has to be as reliable as an anvil. You're only going to get 5-6 hours of sleep even if everything works perfectly, and if you're doubling as crew and driver this is especially important. Big cars like 540s are hard on brakes for example. It sucks to be swapping out rotors and pads and bleeding the system when you could be getting some rest. The suspension will be critical, so make sure you have ground clearance, very solid mounts and preferably skid plates. You would not believe how rough some of the stages are.
The car needs to be nimble for some very tight town stages. It needs to be stable at high speeds, although the overall max is 125 mph. Doesn't sound like much, until you realize that you're doing this on often-battered pavement on a winding road you've never seen before. I'm uploading all of my video, you can see the first few days at http://www.targamiata.com/video.php right now. That might help give an idea of the condition of the stages - especially when you consider my camera simply gave up on the really rough stuff. On at least one occasion, the organizers didn't bother to put a speed bump in the route book because it wasn't an "out of character" bump. You'll also need a wide powerband with lots of torque, but the BMW won't be bothered here at all.
You can swap back and forth between driver and navigator. Hugo and Maxime Vadeboncoeur did that this year, and they were the fastest novice team out there. It worked really well for them because one's a national-level autocrosser (town stages) and the other is a road racer. Still, it's unusual enough to be noteworthy. Most teams will not swap, and I'm glad we didn't.
The goal for your first year should be the Targa Plate. To get this, you need to finish every stage within 135% of your base time. In other words, you have to be consistent. You can't get stuck in a ditch or hobble through a stage with tacoed brake rotors. It's harder than it sounds. This year, 25 out of 46 starters came home with a plate.
Another option would be to run Touring. The speeds aren't as high on the open stages, but the car can be stock. In town, you're going almost as fast as the Targa teams are. In fact, I think a 540i ran Touring this year.