Any image that ends in "-Tiles.ext" (where ext is any image extension) will be available from Ultima's Preferences. Pretty much any image format is fine. Dimensions of 384x512 (32x32 tiles) are recommended for pixel-perfect results in windowed mode, though higher resolutions are okay (and will be taken advantage of in full-screen mode).
Please read the "_About This Folder_" file you'll find in this Graphics folder. Among other things, it tells you about the optional Mini, UI, and/or Font files you can create to match your Tiles. Here's much of what it says in the current build:
LeonMany of the graphics in Ultima III come from this folder, in the form of Tiles, Mask, Mini, Font, and UI. Ultima III's default choice is "Standard", but will make available in its Preferences any Tiles found in this folder. Everything other than Tiles is optional. Pretty much any image format is acceptable. Full screen mode will take advantage of higher resolution files when possible.
Tiles: The regular game graphics, arranged 16 tiles tall by 12 tiles wide. Any resolution is fine, though the native game tile resolution is 32x32 pixels in windowed mode.
Mask: Transparency for tiles. Black is opaque, white is transparent, and shades of grey are partially transparent. Lack of an accompanying mask file means no transparency masking will be used.
Mini: Little tiles for drawing "peer at gem" maps. Lack of a Mini file accompanying your Tiles means that the full-size tiles will be shrunken down for mapping use.
Font: The text in "Classic" appearance. Has no bearing on normal appearance.
UI: Borders, text cursor, dungeon mapping, and moon phase images appear here. Lack of a UI file means the Standard one will be used.
[ Edited to bring up to date for Beta 8 ]