Faisal announced the good news last week: MSBuild will officially support targeting the 1.1 runtime. This was the single biggest complaint I had with the product and Jody and I definitely let Faisal hear about it at the PDC... obviously it was something of concern for a lot of people, so it's good to see this being addressed.
By the way, there are already instructions circulating on how to target 1.1 today (via Scott).
The official fix will be implemented similar to Jomo's solution (i.e., importing 1.1 targets), and we should have a pre-release version in the next couple of months.
That said, not sure whether we will actually be able to avoid a side-by-side installation. I get the sense that there won't be great support for 1.1 development beyond compilation. Web projects may also prove troublesome.
We'll see... it's a start, though.