http://www.downloadsquad.com/2009/11...rage-for-apps/
In the comments and the followup reply from the site. Only the core information needed to launch and maintain the program is put on the internal memory, sounds, graphics, menu's, anything that the app needs to run will be loaded and pulled from the SD card. So yes, it has limitations, but not as extreme as the 256 MB originally thought.
EDIT: Google is also working on a update to the phone that will allow full installation of everything to the SDcard.
http://phandroid.com/2009/11/03/goog...rs-for-app2sd/