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Can a DM take your equipment away or affect your player character directly? This sounds a bit impossible for a story teller to do. I don't personally believe that the DM should be seen as a god in the game.
My group has played D&D for good amount of time, but I have never personally put the time into reading the DM's handbook. An answer or a pointer to a page to read would be great.
The DM can simply declare that rocks fall and everyone dies. The DM can have bolts from the sky strike unruly PCs (a technique suggested--correct me, Comments, if I'm wrong--in AD&D's Dungeon Master's Guide). Certainly, this also includes deleting from the game's reality some equipment. The DM can do anything.
That doesn't mean he should. And if he does--and you don't like it--, you can leave, find another DM, set yourself up as DM for other disaffected players, or take up knitting. So while there's no game without the DM, you should be aware that there's also no game without players. Remember: Participating in an RPG group you hate is worse than not participating in an RPG group at all--or, bad gaming is worse than no gaming.
Mechanically, 3.5 edition's Dungeon Master's Guide explains
The baseline campaign for the D&D [sic] game uses... "wealth by level"... as a basis for balance in adventures. No adventure meant for 7th-level characters, for example, will require or assume that the party possesses a magic item that costs 20,000 gp. (135)
Thus it's possible the DM swiped some stuff off your PCs so the DM can give you different stuff to allow the adventure's completion. It's also possible the DM realized he'd given too much stuff and made a heavy-handed adjustment based on the Wealth By Level guidelines. Given your other experiences with this DM, both seem unlikely, but both possibilities remain.
A roleplaying game is a conversation about an imaginary series of situations and the people in them, with rules about who gets to say what. Different RPGs have different rules about who gets the final say over different things. In D&D 3.5e, the rules give the DM almost all the authority to say what happens. The rest of the players get the authority to say what their characters do and think, but even these can be vetoed by the DM under some circumstances (though different groups and individual players often disagree about where to draw the line between acceptable and unacceptable vetoes).
The DM can hurt and even kill the PCs. Compared to death, taking away a PC's stuff is much less of an imposition. It's very much within the DM's authority. However, taking stuff away (or hurting/killing/etc.) just by saying so is considered extremely bad form, and bad DMing. By contrast, "taking away" stuff through in-game events (e.g., you fall in lava and you barely survive, but the bad news is your leather armour and magic bow burned up) is pretty normal. It's the DM's job to make things happen that make sense and challenge the PCs – having to deal with depleted resources and missing gear is one kind of challenge that DMs sometimes use.
Note that you don't have to play with a DM whose game you don't like: they don't have any authority to make you play in their game. Playing with a DM is a social agreement: I'm going to give you a lot of power, in exchange for giving me an enjoyable game. If the DM doesn't hold up their part of that deal, you can leave and take away the power you gave them. (Though, most people prefer to talk about trying to fix the problem first. Even so, it's not necessary, and you can just walk at any time.)
Although the rules state the GM can do these things, the real question is here is "When should this happen, and how should it happen in a way that is fun, and not un-fun?"
Based on your "GM's shouldn't be gods" comment, my guess is your equipment was stolen, destroyed, or teleported away without a chance to do a saving throw, take action, skill check, or anything, right?
I'm going to point out a very basic game design idea that shows up in more of the modern game design:
When the GM wants to do something negative to the player characters, the players should always get a chance to DO SOMETHING to avoid or deal with it.
Games like Burning Wheel and Apocalypse World are built on this idea of heroic fiction is about protagonists facing consequences - but their protagonism is based in the fact they potentially can overcome the dangers and troubles. When you take that away, not only is it unfun from a story standpoint, it's unfun from a game standpoint - games are built on some element of choice.
Anyway, the answer you're looking for isn't about pointing to a rule in the book and saying "You can't do that", it's going to be talking as a group:
"Hey, let's pause the game. This thing that happened is unfun and unfair because you've taken important abilities away from our characters without any forewarning or chance for us to do anything about it. It feels like getting stuck in a cutscene in a videogame. What's the problem you're trying to solve, and is this the best way of doing it?"
Mind you, that's the discussion to have if your GM is simply at a loss of how to fix something in their game. The unfortunate fact is that most of the time when you have this kind of thing in gaming, it's less "Well, I did what the book told me" and more "I wanted to assert authority" "The players are doing something wrong but instead of talking it out I'll punish their characters" and a lot of other weird passive aggressive things.
You've played with the GM for a year - do they do these kinds of "taking away your choices" things often? That's going to be the easy indicator of whether you should keep playing or just find a new group.
There's a rule for nearly all RPGs (including all editions of D&D) called Rule 0, because it comes before any of the other rules in the rulebook(s). This rule is that the DM is boss. What they say goes, and they can change any rule they want, affect the world however they want.
The reasoning behind it is that a lot of tables playing the same game will lead to slight variations of the game, which the DM can control. He may want to ban certain extension books (commonly called splatbooks), if he feels they don't fit with the campaign. He may want to make a quick ruling on a rules issue so the game doesn't get bogged down while players leaf through several books looking for a single line. Rule 0 is open to abuse, but a bad DM will usually lead to a bad game anyway.
Also, the key role of the DM is that he is the interface between the world he has in his head and on his notes, and the players' characters. If he wants to add an NPC thief who steals gear from you, that's his call. A good DM could create a good plot from this, or use it to start an encounter. Nearly every abuse of DM power could, in the right context, be good.
This should cover both your questions. A DM can directly affect the world if he so desires. He creates it all, and he's the only interface you have to it. He can also make one of these NPCs be 'his' character, and part of your adventuring party. There's a lot more information on DMPCs, as they are called, here.
A corollary to this would be that if the DM is the ultimate arbiter of any disputes, the players have a different but equal power. If the group decides that the DM is not very good at managing their playstyle, or otherwise a bad fit, they can encourage him to improve, decide that it's better than no game, switch to a new DM, or even disband. The DM's power comes from the players, so if your DM(s) is/are generally being unpleasant you can talk to them first, then if they don't improve or don't want to improve you can try to find a new group, take a shot at DMing yourself, or stay with the current group in the same configuration, depending on which appeals to you most.
There isn't a rule against it, and the DM is pretty much all-powerful, though it is pretty much universally considered bad practice without discussing it with the player first.
For example, the DM wants to remove an item from a character: He can remove it just by having it disappear, by having a thief steal it, by having a god appear in front of the character and take it away, by having an opponent sunder it, and a thousand other ways. This approach was common in old-fashioned (Gygaxian) D&D, and there are lots of articles in Dragon Magazine about how to do it.
However, this will usually lead to hurt feelings, angry players and so on; they did a lot of work to get that item and suddenly it is gone. A better approach is to sit down with the players and discuss why you want that item to go away. This avoids hurt feelings, and lets the player understand your reasoning. Perhaps you can find a compromise.
Altering a character sheet is more controversial; Those rules are set out in the players handbook. Sure, a DM can introduce house rules, or have the player pick up injuries or quirks, but I can see a lot of opposition to this. Again, a better approach would be to sit down with the player and discuss why you want to alter their character (It is overshadowing the group say) and see if you can work out a compromise.
There aren't really any RULES when it comes to this sort of thing (Despite the much quoted Rule 0). There are traditions and practices that have been worked out. So yes, the DM can do whatever they want in their own game, but if a DM is too heavy-handed they tend not to have players for very long, so they usually shouldn't arbitraily remove items or alter character sheets.
Obviously there are a lot of opinions on this. But ultimately - without knowing your DM or your experience - I'd say it all comes down to "Did the game feel like art? Perhaps even teach me something?" Because you'll probably never know the "epistemological" reasons, but that doesn't change the subjective effect of what it feels like to play in that person's world. A good DM is an artist. And a good artist does things meaningfully.
So, to tie back to the original question: Of course the DM can take your PC's stuff, but a good DM will always have a reason, and that reason will be either be linked to the story, or at least it will serve as exposition for the game world (i.e., "these are the sorts of things that can happen in this world.") It should never be a personal reason, a power trip, or a vendetta against a player. Hostile DMs should be boycotted.
