Windows 2003 expands on the mixed mode/native mode functionality of Windows 2000 with functional levels. Windows 2000 included the ability to run NT4 BDCs in a Windows 2000 AD domain if it was in mixed mode. Windows 2003 includes this and expands on it to include forests. There are 3 forest functional levels and 4 domain functional levels.
The 3 forest functional levels are:
Windows 2000
This is the default for new 2003 domains and those upgraded from Windows 2000. At this level all the new forest-wide 2003 Active Directory features are disabled with the exception of one. Windows 2000 mode takes advantage of the improved Global Catalog replication scheme. Now when a new attribute is added to a GC, only that change is replicated and not the entire GC. In larger or low bandwidth environments this can be quite advantageous. You must use this mode if you have or will add Windows 2000 Domain Controllers in your forest.
Windows Server 2003 Interim
This is a special functional level and only appears when upgrading from NT4 to Windows 2003 AD. This level is set when the NT4 PDC is upgraded to Window Server 2003 and includes the same limitations as the Windows 2000 functional level.
Windows Server 2003
In order to take advantage of the new forest wide features in Windows 2003 AD, you need all DCs in the forest to run Windows 2003 and you need all domains in the forest to be at the Windows 2003 Domain functional level. Once in this mode you cannot add any NT4 BDCs or 2000 DCs anywhere in the forest. You can still run NT4 and 2000 Server as member servers.
So what are these new forest-wide features? Improved Active Directory and Global Catalog replication, and linked value replication all improve the efficiency of replication. There are also some schema changes including Defunct Schema Objects. You cannot delete an object from the schema however it is possible to mark them as defunct. Doing so allows you to deactivate unnecessary classes and/or attributes.
The two biggest new features would have to be Forest Trusts and Domain Renaming. At the Windows Server 2003 forest functional level you can now create a trust between two 2003 forests instead of having to create and manage separate trusts between each domain and child-domain between two forests. Finally with at this level we can rename an Active Directory domain without demoting it and re-promoting it. This is a bonus to those takeover hungry corporations.
To raise the forest functional level we first need to ensure all domains are at the Windows 2003 Server domain functional level. Once you have verified this, open up the Active Directory Domains and Trusts MMC. Right-click Active Directory Domains and Trusts and select Raise Forest Functional Level.
Verify the forest name and the current level then select the Windows Server 2003 level and click Raise.
The change will be made and replicated to all other DCs in the forest. We can verify the change was successful with LDP.EXE. From a command prompt run LDP.exe. Click Connection and the Connect, and click OK leaving all info as default. In the right pane look for the following section, I have highlighted it.
1> forestFunctionality: 0 = Windows 2000
1> forestFunctionality: 1 = Windows 2003 Interim
1> forestFunctionality: 2 = Windows 2003