No provisioned iPhone OS device is connected when upgrading to iOS 4.0

You get the error message because the state between iTunes and xcode isn't synchronized. You have to login to iTunes and click on the "Use for Development" button on the bottom center of the screen. You have to wait for the little green light to show up next to the ipod or iphone device listed in iTunes. I saw a greyed out grey light indicator, it was not green. Once iTunes was able to sync up by logging into the Apple Developer center, the xcode error disappeared. Crappy UI.