Agh, that always catches me out. Sorry about that, irrelevant advice for you then. Although I would say that doing this in TG2 will give you better results. But nevertheless, some advice on the TG Classic approach.
First, what TheBlackHole said is a good start. It's not absolutely necessary that it be totally square and a "Power of Two Plus One", but it makes it easier to work with as these are TG Classic's standard terrain sizes. If you have trouble with the formats, you could try saving your image as a 16 bit TIFF and using TerraConv to convert directly to .TER. Once you have successfully imported your image, you may want to make it look a bit more like real terrain (rather than the very smooth terrain shapes you will likely get after first import). For this you can use Generate Terrain then select "Generate Features on Existing Terrain" and use relatively small "Size of Features". This should rough up your terrain a bit while maintaining the basic shapes. Unfortunately TG Classic has no Erosion functions, which would help add some realism.
With that in mind you may have better luck either working in TG2, or using a dedicated heightfield editor like Wilbur, World Machine, etc. and then saving as TER and importing into TG Classic.
- Oshyan