OutOfMemoryError calling XmlSerializer.Deserialize() - not related to XML size!

EDIT: This was not the solution, unfortunately, but it may help others track down a very similar problem. This answer here is the actual solution.

I've believe I found the solution to this problem. It is a bug in .NET 3.5 SP1.

Serialization hangs or throws an OutOfMemoryException with static delegate and ISerializable on 3.5 SP1 (ID: 361615):

When a generic class implements ISerializable and has a static delegate member that makes use of the generic type arguments, binary deserialization hangs (on a 32-bit system with Windows Server 2003) or throws an OutOfMemoryException (on a 64-bit system with Windows Server 2008).

This error occurs with .NET 3.5 SP1 and did not occur with .NET 3.5 without SP1.

The solution is to install KB957543 hot fix.

You haven't provided enough details to recreate your problem. But, the reader implements IDisposable and should be disposed of properly. Preferably by wrapping it in a using block. Most developers never run into a problem when they forget to dispose of something because the garbage collector will eventually clean up the mess. However, it isn't hard to code something that causes problems before the GC gets around to cleanup, or even prevents cleanup entirely.

public static T DeserializeXmlNode<T>(XmlNode node)
{
    XmlSerializer xs = new XmlSerializer(typeof(T));
    using(XmlNodeReader xr = new XmlNodeReader(node))
        return (T)xs.Deserialize(xr);
}

Based on the documentation of the XmlSerializer class you should cache the XmlSerializers otherwise you can cause poor performance or a memory leak.

Hashtable serializers = new Hashtable();

// Use the constructor that takes a type and XmlRootAttribute.
XmlSerializer s = new XmlSerializer(typeof(MyClass), myRoot);

// Implement a method named GenerateKey that creates unique keys 
// for each instance of the XmlSerializer. The code should take 
// into account all parameters passed to the XmlSerializer 
// constructor.
object key = GenerateKey(typeof(MyClass), myRoot);

// Check the local cache for a matching serializer.
XmlSerializer ser = (XmlSerializer)serializers[key];
if (ser == null) 
{
    ser = new XmlSerializer(typeof(MyClass), myRoot);
    // Cache the serializer.
    serializers[key] = ser;
}
else
{
    // Use the serializer to serialize, or deserialize.
}