I would say if at all possible keep the DC motor, it will be much better than an AC Induction motor and VFD, more torque through the range and most likely better speed control.
Regardless of what you have for a motor you will be able to thread, assuming it is powerful enough not to slow down too much under load. All that is required is an Index pulse per rev fed back to Mach.
Now regarding the encoder, it all depends on what hardware you use, if using an external controller then the Index pulse from the encoder will be of too short a duration for the PP to see so you will need another means of getting an Index to Mach, most use an opto switch and a disc with a single slot.
If you use an external controller then it is likely the Index pulse from the Encoder will work well. Be aware however that not all external controllers can do lathe threading, so before you buy one make sure it can.
Personally I would try and keep the axis motors and drive that are on the machine, they will almost certainly be high quality industrial drives. They will also almost certainly be analogue command, ie +/- 10v command. If that is the case then your choice of external controller is between the few that can output +/- 10v.
The ones I know of are
CSMIO/IP-A
DSPMC
Kflop with Kanalog
Galil.
The only one I have used of the above is the CSMIO/IP-A, I think it is a great controller but the drawback for the lathe is the threading is slow to pull out at the end of each pass and thus a groove is cut at the end of the thread, if this is not a problem then it works exceptionally well as it uses the full encoder for threading. That means you can actualy slow the spindle right down and speed up again and it track perfectly.
The IP-A can also do rigid tapping by means of the M74 macro supplied by CS-Lab, that works great as well.
Here is a video showing my wee lathe doing threading, it has the IP-S , the difference being it is step/dir but other than that it is the same as the IP-A.
https://www.youtube.com/user/HoodScotland/videos?sort=dd&view=0&shelf_id=1Here is a vid of my Chiron doing rigid tapping, it uses the IP-A.
https://www.youtube.com/watch?v=GNL2XdsJz2EOf the other controllers mentioned above I am not sure whattheir capabilities are regards threading and rigid tapping, I know the Galil can use full encoder and I think also the Kflop/Kanalog does but not sure about the DSPMC.
Regarding rigid tapping, I know the Kflop/Kanalog can do it with a macro in a similar manner to the CSMIO but not sure about Galil and DSPMC.
Hood