Don't knock the IPT 2G. Mine still works like a champ, connects to the wi-fi with WPA (WPA2 even, I believe) and the net works quickly, smoothly, and there aren't any drops. Sounds as if something's gone kerflooey with the one you have. [Note: I am still running iOS 3.1.3 and did NOT upgrade to iOS 4 given all the negative reports--battery life, slow downs, etc.]
As to the Apple store, it would have been incredibly generous of them to have given you a new unit when you were 1 year out of warranty. That's really expecting far too much. Not doing that for you doesn't mean that they have poor customer service. In fact, they investigated the problems and gave you an option for a fix. You could try another Apple store, although you'd probably be better off looking for an online repair specialist that could probably fix it for less.
At the same time, let me put a plug in for Apple--in other cases, when a known design defect emerges, they have been incredibly good about replacing things out of warranty. It's too bad that wasn't the case in your situation!