According to istartedsomething, the modding community is making some headway in jailbreaking Windows Phone 7. Microsoft has chosen to go the Apple route and is not allowing sideloading of apps on the devices. Furthermore, apps must run in the managed environment of Microsoft's Silverlight architecture. The first step in a stable jailbreak has been accomplished by Australian developer Chris Walshie. Walshie has been able to build an app out of native code, and run it on a retail Windows Phone 7 handset.
The breakthrough was made possible by users of the XDA Developers forums who found a Samsung app in the official Marketplace that used native code. This app contained a DLL that enabled root access to the core of the Windows CE-based system. All that remains is devising a method of sideloading native code apps on a retail (non-developer) device. We have confidence that the community will work something out sooner rather than later.