So with Alchemical Allocation, I can drink and spit out potions. Does that mean that I can do it to the same potion everyday indefinitely?
Yes, that is the point of it.
On another note, I would like to use it on a +5 Magic Vestment potion, which costs 3k gold. Since only a level 20 Druid can cast a +5, does that mean that the Potion will last 20 hours? Does that mean that every day, I can sacrifice a level 3 extract for +5 AC for 20 hours at the cost of 3k?
Yes. However, note that you actually need to have a level 20 caster to do it, because Potions are a specific exception to the "just raise the Spellcraft DC by 5" thing you can do if you can't otherwise cast it. In this way, your GM has an easy way to prevent you from pulling this off--"there aren't any level 20 divine casters around making potions like this."
Does it stack with Alchemist's Extend Potion discovery, which would extend it to 40 hours, allowing me to have a permanent +5 AC if I keep allocating it every day?
Yep, that is exactly the point of the ability.
P.S. If yes, my GM would probably punish me pretty quick for 'over exploiting' the system :P
If he does that:
1) He's overreacting, because this is specifically a class feature of the Alchemist and is exactly how it is intended to work and be used--it is assumed you'll be able to abuse potions and get awesome benefits from that--it is factored into the class's power level.
2) He's foolish, because he could very easily have squashed the whole thing by just not having level 20 divine casters making potions in town.
I don't think you make potions of magic vestment (have to be oils or something) since it targets an item, not you. But I believe the rest of your ideas are sound.
I thought the same thing, but potions just have to target one or more creatures or objects. Go figure.