WeiPhone is reporting that the iPhone 3GS is capable of playing back both 720p and 1080p video encoded in H.264 through the built in player.
iLounge notes that Apple may be putting arbitrary limits on video playback to save battery life keep things consistant with previous iPhones.
Using the free document storage and viewing application FileAid, forum member fridtear was able to circumvent Apple’s video restrictions, smoothly playing back files up to 30 Mbps in 1980x1080 resolution via the iPhone 3GS’ built-in video player.
Its possible that Apple may be saving this feature for a supposed firmware upgrade or possibly even for the next iPhone HD.
News of this capability was rumored in April along with a new Apple AV Cable to allow for both component and composite on the same cable.
-- Post From My iPhone3gs