It seems you have to choose to use VS2008 to target .Net 2.0 OR choose to use extension methods.
But you can't pick both.
Extension Methods are actually implemented entirely by the compiler - no new IL instructions within the CLR are required to support them.
This means that you can use the VS "Orcas" C# compiler and write code that uses Extension Methods, and use the multi-targetting features to run it on a vanilla .NET 2.0 box.
However the ExtensionAttribute (required to mask a method in a module as being an extension method) is not available to add to a project which targets .Net 2.0