1. Go to iTunes and select whatever song you want for the ringtone
2. Go to the info panel for that song
3. Put the start and stop information in for what chunk of the song you'd like to have as a ringtone and close the info panel
4. With the song still highlighted, head to the advanced menu and select "Convert Selection to AAC"
5. When it's done, delete the reference to the new song in iTunes but do not delete the file itself
6. Locate the file and change the extension to .m4r
7. Double click on that new file and it should show up in iTunes under the ringtones category
Now you can just sync up your ringtones like your would if you had bought them. BTW, I've done this on a 1.1.3 jailbroken and iTunes 7.6