Building .NET 3.0/3.5 projects from Team Foundation Build 2005 not supported. Team Foundation Build 2005 will always invoke the 2.0 Framework's MSBuild.exe, which does not support building solutions that target the 3.5 Framework. (The 3.0 Framework shipped with Vista, while the 3.5 Framework is shipping with VS 2008.)
The 3.5 Framework includes new MSBuild bits which allow multi-targeting - i.e. MSBuild 3.5 can target the 2.0 Framework.
We can convert our solution to VS2008 beta 2 and target the solution to .NET framework 2.0. It's not enough. When we'll try to build this solution with Team Foundation Build 2005, we'll get an error MSB5014 - File format version is not recognized.