The custom explorer's selection and expansion state is only retained, if the label of the tree node does not change.
If the label changes (e.g. because one part of it reflects a dynamically changing status), the selection and expansion state is lost.

Please note that in my TreeDataProvider implementation I'm returning the same TreeItem instance for the same tree node, so I'm not deleting a TreeItem and I'm not creating a new in its place. In this case the VS Code custom tree should have no problem to preserve the selection because the TreeNode instance does not change (only its label). It should not use the label as a unique ID but assign a unique ID to the TreeItems on its own.

And even when using a TreeDataProvider implementation that returns new TreeItems on every refresh it should be possible that the selection is preserved. For this the TreeItem could support an id attribute that could be overwritten if necessary.

Since the lost selection makes a dynamic tree very difficult to use for users, I think this is an "important" bug.