VS.NET 2003 & VS 2005

Can i use 2005 for 1.1 Framework and loading other projects that i had in 2005 or would it be better for me to install both?

VS.NET 2003 is incapable of targeting version 2.0 of the Framework. VS 2005 is incapable of targeting version 1.x of the Framework. VS 2005 will upgrade projects created with earlier versions with very little fanfare, although some small changes may be required. Also note that the VB 2005 compiler is better than the VB.NET 2003 version and will warn you about certain things that could potentially cause issues that the were previously ignored. Note that any upgraded projects will not be able to be opened in the earlier version afterwards, although I beleive that a backup is created. It might be a good idea to take your own backup anyway, just in case. There is no issue running more than one version, although it is preferable to install the earlier version before the later one.

In my friends open source project he has (preproccessor?) commands like

#if .NET_2_0
then he does something different

He has that in his 2003 project, how does that work?

When you use conditional compilation the compiler doesn't even look at any code that falls outside of the current set of defined constants. You can put anything at all in sections of code that are excluded form compilation because the compiler simply ignores it. Note that a code file is just a text file. You can view any code file in any version. The compiler may give you compilation errors if the code is not valid but you can still open it. It is solution and project files that contain information about what version of the IDE that was used to create them. Try opening a SLN or VBPROJ file in Notepad to see what sort of information they contain. You can edit it by hand if you know what you're doing to swtich from one version to another. There are also utilities available that will make the required changes for you, like downgrading a project from 2005 to 2003. That doesn't mean that your code will compile though.