UPDATE

Don’t use the Sharepoint Solution Generator, so far we have not been able to upgrade the site definitions through a solution without it killing existing sites based on the site definition. 

I have seen many different ways of doing this, but I found the following method seemed to work for me, using the “SharePoint Extensions for Visual Studio 2005″ and the “SharePoint Solutions Generator“

• Use the “SharePoint Solution Generator” to create a site definition project.
• Open the project and add your custom master page to the “Site Definition” folder

• Open up “onet.xml”
• Add the following node to the “ListTemplates” section

<ListTemplate Name=”mplib” DisplayName=”$Resources:MasterPageGallery;” Description=”$Resources:global_onet_mplib_desc;” SetupPath=”global\lists\mplib” Type=”116” BaseType=”1” Path=”GLOBAL” Hidden=”TRUE” HiddenList=”TRUE” NoCrawl=”TRUE” Unique=”TRUE” Catalog=”TRUE” OnQuickLaunch=”FALSE” SecurityBits=”11” AllowDeletion=”FALSE” AllowEveryoneViewItems=”TRUE” Image=”/_layouts/images/itdl.gif” AlwaysIncludeContent=”TRUE” DocumentTemplate=”100” />

• Add the “MasterUrl” attribute to the “Configuration” node with a value of “_catalogs/masterpage/project.master”, where project.master is the name of your custom master page. This means all the pages using the “~masterurl/default.master” token will use the URL defined to point to your custom master page

<Configuration ID=”0” Name=”Default” MasterUrl=”_catalogs/masterpage/project.master“>

• Add a “Module” node to the Modules section of the configuration called “MasterPage” that will reference the module definition in the “Modules” section of the onet file

<Module Name=”MasterPage” />

• Add a module definition to the “Modules” section of the onet file. This will copy the custom master page file into the master page library when the site is provisioned.

<Module Name=”MasterPage” List=”116” Url=”_catalogs/masterpage” RootWebOnly=”FALSE“>

<File Url=”project.master” Type=”GhostableInLibrary” IgnoreIfAlreadyExists=”TRUE” />

</Module>

• Save the onet file and then deploy the project into your environment using the deploy option in “SharePoint Extensions for VS 2005″
• When you create a new site from your site definition it should now use your new master page.

Below is a screen grab of the onet.xml file with all the changes highlighted