256MB of rootfs probably won't fit onto 128MB SD/MMC - that's 256MB of physical storage, but as the filesystem used by rootfs is JFFS2 the data is already compressed so you could, in theory, wind up storing double that amount of data (depending on how well it compresses).

I suppose what you are trying to achieve (ie. backing up rootfs) might be feasible, but I find it an awful lot easier to keep an online page of the apps I install - specifically a list of the one-click install files. Last time I reflashed I had all my apps reinstalled within 20 minutes. A fully automated application rollback script would be better, ideally this would be a part of the Application Manager but one can only hope...

Booting off MMC is another option as this may be easier to maintain but I've always found that rootfs on MMC is too easily corrupted for it to be used for a "production" system. Also, each time you update an app you would need to backup your rootfs again... in my opinion it would all become far too tedious in the long run and the occasional reflash/reinstall isn't that much of a hardship if you can create yourself a web page of one-click install links.