My HDTV has no 720p mode just 480 & 1080i, I would really love to watch videos at the higher resolution but it looks like the XBOX can't handle the load. Would it be possible to offload the heavy processing to the PC and just stream the processed data to the xbox?

XBMC cant do it. And I don't beleive it's posible; there is no "Video-in" hardware built into the xbox.

I don't even think the DVD player has a hardware mpeg decoder? and thats not even what your asking.

Uncompressed video straight to the video output of the xbox. Maybe one day

It would be cool if you could add a video in to the xbox (tivo-xbox anyone?). But you were right in the last line of your response, I was wondering if you could just stream the decoded information straight to the xbox hardware using XBMC simply as a pass thru. It seems logical enough but then again I am not a programmer. I guess what we would need would be some software bridge that allowed you to deliver the information from a IP network straight to the Xbox hardware layer.