Madrid is probably my favorite city on earth. You'll have a great time.

We're big Starwood whores, so we always stay at the Palace. The hotel is very early-1900s Europe. The public areas, particularly the stained glass cupola, are beautiful and well maintained. The rooms are nice, but some are a bit worn. Try to get a room with a view of Pseo del Prado or Callao. The "courtyard" view rooms and those that overlook the smaller streets aren't as nice.

The hotel's location is great. Is is a bit of a walk to the nearest metro (there are three that are each about 500M+ away). But, the Prado is right across the street. Its a short walk to Plaza Santa Ana (a good place to start a tapas crawl), and Puerta del Sol (the center of the city).

For sights, definitely see the Prado. It is a fairly big museum, so we usually focus on a couple of painters (The Big Three - El Greco, Velazquez, and Goya, for instance). Also, the other half *loves* the object d'art collection in the basement.

After the Prado, the Reina Sofia is the other must-see museum. You have to see Picasso's Guernica at least once. I also like the Miro and a few other works there. A lot of the rest of the collection leaves me cold. Other people really like the Thysen. I've been once, and see no need to return.

Madrid is ringed by some incredible medieval sights -- Toledo, Segovia, El Escorial, etc. Of them all, Toledo is my favorite. They were constructing a high speed train line Madrid-Toledo the last time we were there. They might be done by now. In any event, catch the train from the Atocha station (a quick cab from the Palace). In Toledo, don't miss the Cathedral or El Greco's "Burial of Count Orgaz". Also, I'd highly recemmend taking a cab to the Parador. The view of the city from their terrace is stunning. It's a great place to sip a cocktail and rest your feet.

Back in Madrid, the best part of the city is the nightlife. We usually make a dinner of tapas (who wants to eat dinner at 11PM?) Our favorites, between Plz St Ana and Pto del Sol are:
Las Bravas - for the eponimous potatoes
El Abuelo - for the garlic shrimp
La Zapateria - for the pincho muruno

After we get our fill of tapas, we usually metro from Sol to Chueca. My favorite bar is "Why Not?" It is actually mixed (about 50/50). But, on weekends, it gets packed and is a ton of fun. On our last visit, we also really liked Liquid.

If you can hold out until about 2:30am, try Pasapoga. Great disco, a must see. Unfortunately, it was closed for remodeling when we were there last.

Can't recommend any "wilder" places as I'm a married man

For a great general (ie not gay) overview of Madrid, check out Maribel's files at http://maribelsguides.com/