Thanks for your Question. It's a difficult one to pick through unfortunately.
If you have obtained a UK passport then your earlier ancestry visa would have been been cancelled had the UKBA become aware. At the point of obtaining your passport your wife should then have applied for an in-country spouses visa (ie. Settlement) if your marriage was still subsisting.
It would be best if you both regarded your separation as a temporary separation and not the ultimate end of your marriage for now.
In the long term, you can apply for further leave to remain for your children on the basis of you having a British passport and living in the UK. The problem with this is that when you do you will open the can of worms with your wife's status. If the marriage is no longer subsisting then the UKBA will consider the status of your wife when your children's leave to remain is considered. They will hold that she does not technically have leave to remain because your marriage is no longer subsisting. She would then have to apply for discretionary leave to remain on the basis that he children may be here after being granted further leave to remain. This is tricky and not guaranteed, so you will all have a fight on your hands.
If you do genuinely reconcile then she can apply for ILR but this will not be successful if you are living at separate addresses.
You are supposed to report and change in circumstances to the UKBA. If it is only a temporary separation then you could argue that this is not a material change in circumstances.
In terms of your wife's application if you pass your SA passport to her then she could apply with it but if the UKBA found out then you would face some tricky questions on why this was submitted and not your passport. You could rely on this being your "honest mistake" on the basis of your misunderstanding the rules and would be unlikely to face any penalty in this regard. Your citizenship would not be revoked, this only happens generally where it has been obtained by fraud.
Sorry it could not be better news.
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