We are thinking of upgrading the .Net Framework 3.5 to 4 while an existing Windows SharePoint Services v3 is running. Is this safe or it will break the installation. Would there b3 any impact on the sharepoint instance?
.Net 3.5 and 4 have different CLR versions and can be installed side by side on the same machines, so you can install .Net 4 on your SharePoint servers with no problem.
But code written for .Net 3.5 can't run on the new CLR without a recompile, so you can't swithch your SharePoint application pools to run .Net 4, but you may have other web sites, services, utilities, ... running .Net 4 on the machine. These will not be able to use the SharePoint object model though.
The upcomming SharePoint 2013 is running .Net 4.5