A presumably candid post from the IEBlog reveals that Internet Explorer 7 will not support the MIME type "application/xml+xhtml". The reason given is that implementing this in IE7 would be done using the HTML parser and could end up being a hack. Chris Wilson hints that a future version of IE will support the MIME type and it will be implemented properly. As long as the release schedule for Internet Explorer is under a year per version, I'm happy with that.
They do reveal that IE7 will properly skip the xml prolog and handle XHTML in strict mode (instead of quirks mode). He also states that it is relatively easy to configure a web server to serve text/html instead of application/xml+xhtml when the user agent does not support application/xml+xhtml. This is a step forward, but it looks like XHTML will still go nowhere until IE8.