I decided to take a stab at this and boy, it's a lot of work with little progress using an internal iframe node as a handle. Anyway, here are two solutions, the first one doesn't work really well, but if you can get it to work, it may be more desirable.
main.html (plagiarized from the demo)
<div id="draggable" class="ui-widget-content" style="position:relative;">
<p class="ui-widget-header">I can be dragged only by this handle</p>
<iframe name="iframe1" src="inner-handle.html" height=50 width=80></iframe>
</div>
inner-handle.html
<html>
<head>
<script type="text/javascript" src="../../jquery-1.4.2.js"></script>
</head>
<body>
<div id="innerHandle">handle</div>
</body>
</html>
JavaScript
$(function () {
var moveEvent;
$(document).mousemove(function (e) {
moveEvent = e;
});
$("#draggable").draggable();
$('iframe', '#draggable').load(function () {
$('iframe', '#draggable')[0].contentWindow.$('#innerHandle').mousedown(function (e) {
$('#draggable').draggable().data('draggable')._mouseDown(moveEvent);
return false;
});
});
});
It took me a while to find something that "worked." The problem here was that since the mousedown event occurred on an element inside the iframe, the mouse event is relative to the iframe, not the main document. The workaround is to have a move event on the document and grab the mouse position from there. The problem, once again, is that if the mouse is inside of the iframe, it is "not" moving according to the parent document. This means that the drag event only happens when the mouse reaches the edge of the iframe into the parent document.
A workaround for this might be to manually generate events with the calculated position of the iframe relative to its mouse movement. So when your mouse moves within the iframe, calculate its movement using the coordinate of the iframe to the parent document. This means that you need to use the event from the mousedown and not the mousemove,
$('iframe', '#draggable')[0].contentWindow.$('#innerHandle').mousedown(function (e) {
// do something with e
$('#draggable').draggable().data('draggable')._mouseDown(e);
return false;
});
The second solution is the way you have mentioned, have an absolute positioned div over the iframe itself. I have no trouble in getting the div to be on top of the iframe, that is,
<div id="draggable" class="ui-widget-content" style="position:relative;">
<p class="ui-widget-header">I can be dragged only by this handle</p>
<iframe name="iframe1" src="inner-handle.html" height=50 width=80></iframe>
<div style="position: absolute; height: 30px; width: 30px; background-color: black; z-index: 1000;"></div>
</div>
The problem with your div being behind the iframe might be because the z-index is off. If you declare your div before the iframe and you didn't specify the z-index, then the iframe will be on top.
Whichever way you choose, good luck!