You may have noticed that SQL 2008 SP1 was recently released. I’ve seen a flurry of questions about whether or not TFS 2008 SP1 will work with SQL 2008 SP1. The good news is that the answer is yes. The bad news is that there’s a work around you may have to do to get it to install. The problem has to do with version checks that the TFS installer does to ensure the SQL version is compatible. The checks are too restrictive and even though it will actually work, the installer will tell you the SQL version is incompatible.
Because of the nature of the problem, the install order matters. If you already have TFS 2008 SP1 running with SQL 2008, and you want to upgrade SQL to 2008 SP1, that will just work – because you aren’t running TFS setup where the block happens. If, on the other hand, you want to install TFS 2008 SP1 using an already installed SQL 2008 SP1 server, you will need to modify an XML file to get around the block.
The process has been documented in this KB article.