Using Windows 7 XP mode to do development

Yes it is reliable enough (well about as much as you trust MS), a colleague runs the same setup for a VS 2003 and 2005 project, development works great.

XP Mode is basically a Microsoft Virtual PC pre-installed with XP SP3, bundled and configured with Windows 7. So yes you should be able to connect to your XP mode SQL Server from the host, as the VPC allows host-guest networking.

As far as I know:

if your computer is powerful enough to run that software in another VM, XP-mode is as good as any other (theoretically)

Apps installed under your XP Mode will run "seamless" (so no Window around it), but off course are crippled since they aren't natively on your system. They also won't support the Windows 7 eye-candy as far as I can test it now.

To be sure: create an image or vhd of your current XP installation, then switch to Windows 7. If it all doesn't work out, you can easily switch back!

Assuming you have the appropriate hardware, this should work just fine. XP Mode can either run the applications seemlessly and look like native Win7 applications, or you can open the VirtualPC image directly and interact with them in their native environment.

One of the great uses of XP mode is to be able to side-by-side install applications that otherwise wouldn't co-exist on a system. This is a great use of that ability.

Assuming you have the appropriate hardware,

There is more to this than just having enough horsepower. The CPU must have "virtual" capabilities and it may have to be enabled in the BIOS. If your machine is too old you may not have this option.

See this thread for all the details.