This happens in 2.5 b557 and before.
When I try to make a Level 5 sword I can't and use it.
I set it up the exact same way as the level 4 sword in the item editor, the only difference is that it is level 5 and deals more damage.
It appears on the active subscreen after I pick it up but I cannot use it. It DOES NOT appear on the passive subscreen.
Before I pick up the level 5 sword:
After I pick it up:
Confirmed, it's been known for a while too.
http://www.purezc.com/forums/index.php?showtopic=30666
This thread contains a lot of information on the bug, and Majora (Majora's Wrath over here) confirms that the sword works fine if and ONLY if "Can Select A Buttons on Subscreen" is checked. I reported this same bug way back in the 300s, and it's still not fixed.
I started that thread at PZC Ebola... I hope they fix it soon.
Con-fucking-firmed.
Though the ability to use custom swords if "Can Select A Button" is checked is a new one to me. I'll check that as a workaround for now.
Bug still exists in 564.