Building on #1.

For context here's my desired workflow:

1. Set up a repo for a magento store. Seperate repos for modules (third party or own doesn't matter)
2. Use modgit to install and update modules, adding them magento repo as feature branches etc
3. Switch branches to work on other functionality/modules etc.
4. Switch back; merge, push => deploy etc.

To do this I do not ignore .modgit/, I want it to be portable between team members.
Currently I'm seeing untracked files when switching between branches, specifically .modgit/module/source. I think this is due to the .git folder up the tree.

I had breifly flirted with submodules for this task, but in addition to #1 they bring with them a lot of pain in other areas.

git subtree looks like it'd be ideal for this task.
I've hacked together a working git subtree implimentation of modgit over at https://github.com/rjocoleman/modgit/tree/subtree
Please note, it's not battle tested - a prototype at best. Several things are broken such as modgit update-all.
However switching branches etc does perform as I'd expect (i.e. no untracked files)
modgit clone and modgit update have been implimented (albeit with a slightly changed syntax for update).

I'm going to continue testing and refining this as I go, I'm keen to hear feedback on this direction. With subtree living in the git's contrib folder I don't see this as being much more than a runtime option at this point.