You need to comment out the old references to System.Web.Extensions and System.Web.Extensions.Design and add in 3.5 ones in your web.config:
<!-- <add assembly="System.Web.Extensions.Design, Version=1.0.61025.0, Culture=neutral, PublicKeyToken=31BF3856AD364E35"/> -->
<!-- <add assembly="System.Web.Extensions, Version=1.0.61025.0, Culture=neutral, PublicKeyToken=31BF3856AD364E35"/> -->
<add assembly="System.Web.Extensions, Version=3.5.0.0, Culture=neutral, PublicKeyToken=31BF3856AD364E35"/>
<add assembly="System.Web.Extensions.Design, Version=3.5.0.0, Culture=neutral, PublicKeyToken=31BF3856AD364E35"/>
To prevent them from being added back, you'll need to do the removal of the 1.0 versions from the GAC using gacutil:
C:> cd C:\Program Files\Microsoft Visual Studio 8\SDK\bin
C:\Program Files\Microsoft Visual Studio 8\SDK\bin>gacutil /u "System.Web.Extensions, Version=1.0.61025.0, Culture=neutral, PublicKeyToken=31BF3856AD364E35"
If you have to remove a reference, you could try
gacutil /u /r "System.Web.Extensions, Version=1.0.61025.0, Culture=neutral, PublicKeyToken=31BF3856AD364E35" FILEPATH C:\WINDOWS\system32\msiexec.exe "Windows Installer"
http://msdn.microsoft.com/en-us/library/ex0ss12c(v=VS.71).aspx would be your reference on syntax. The above was what I tried to get rid of a reference to the DLL from Windows Installer, but it didn't work since it was a registry reference, not a FILEPATH one, or one FILEPATH could remove, I guess. Whatever I needed, it wasn't provided on the site. So a-hunting I went in the registry for "System.Web.Extensions". I found entries for it, and its "Designs" version under HKEY_CURRENT_USER\Software\Microsoft\Installer\Assemblies\Global. After I deleted the 2 entries, I could remove them using the first gacutil command I have up there just fine (re-running it for the "Designs" one). &%$# Microsoft!!!
-Tom
P.S. If you don't have the SDK for VS 2005, you can also get to gacutil at C:\WINDOWS\Microsoft.NET\Framework\v1.1*. Or just go to C:\WINDOWS\Assembly and find the right ones (careful!!) and press Delete.
P.P.S. You may get one of those "ambiguous reference" errors if you have the AJAX Control Toolkit and it's auto-refreshing the 1.0 DLLs into your Bin - it might not know whether to use the GAC or your Bin for the 3.5 DLLs. In this case, I had to add these entries to the top of my ASPX page:
<%@ Assembly Name="System.Web.Extensions, Version=3.5.0.0, Culture=neutral, PublicKeyToken=31BF3856AD364E35" %>
<%@ Assembly Name="System.Web.Extensions.Design, Version=3.5.0.0, Culture=neutral, PublicKeyToken=31BF3856AD364E35" %>
I probably just as easily could have made them 1.0 versions and seen if that would've worked...