Apple TV plays back iTunes HD content, HD home videos, and HD podcasts all at 720p internally, but can deliver either a standard 720p signal or an upconverted signal to the HDTV set as 1080p. How noticeable this difference is in the picture displayed depends upon the quality of the video circuity in the TV being used. Many consumer oriented HDTV sets use cheap picture scaling and conversion hardware that will result in the Apple TV's new 1080p mode serving as a nice feature, as the TV won't have to handle the conversion itself.
Using a high quality HDTV set, we couldn't see any visible difference in using 1080p over 720p from Apple TV, even when looking up close and trying to find differences in the static frames of movies or in the unit's own menu titles. However, some cheaper HDTV sets might deliver a better picture using the 1080p signal setting. Rather than being excessively concerned about 720p versus 1080p, the main value added by Apple TV is its low cost delivery of easy to access HD content, both for rent and for free.