Will 1080i sources look a lot better on the 1080p TV? Will DVDs and SD TV actually look better on the 720p TV? While I will watch some HDTV and DVD movies, the majority will be SD, as that is what is currently available.
1080i should look better on a 1080p display than on a 720p display. The 720p display must scale the image, losing data in the process. The 1080p display can combine the two 1080i interlaced fields to create a single, high-resolution image that will have more detail. Unfortunately, some early 1080p models only show one 1080i field — expanding the 540 lines to fill the screen by doubling — and throwing away the other field. The “right” way is referred to as “weaving” and the throw-away method is called “bob” by some. So a good 1080p display will show 1080i content better than a 720p display, but some 1080p displays could be the worst.
DVDs and progressive scan images can look much better on high-res screens. They can’t create the missing data required to fill out the extra pixels, but some do a remarkable job of scaling the data so it appears that you have more detail. This is often called “up-converting”, which I personally think is a terrible name for it. I don’t think that 720p has an advantage over 1080p for scaling SD content, however.
I think the more important question is whether or not you’ll be able to see the difference between 720p and 1080p. You need a very large display for 1080p in most viewing situations, and the range of distance between too close and too far is fairly small. In many instances, the 720p will serve just as well. So I recommend that you start with the screen size calculations at the different resolutions, and see what size screen will be right for your room.