I have formatted text (with newlines, tabs, etc.) coming in from a Telnet connection.  I have a python script that manages the Telnet connection and embeds the Telnet response in XML that then gets passed through an XSLT transform.  How do I pass that XML through the transform without losing the original formatting?  I have access to the transformation script and the python script but not the transform invocation itself.
Data stored in XML comes out the same way it goes in. So if you store the text in an element, no whitespace and newlines are lost unless you tamper with the data in the XSLT. 
Enclosing the text in CDATA is unnecessary unless there is some formatting that is invalid in XML (pointy brackets, ampersands, quotes) and you don't want to XML-escape the text under any circumstances. This is up to you, but in any case XML-escaping is completely transparent when the XML is handled with an XML-aware tool chain.
To answer your question more specifically, you need to show some input, the essential part of the transformation, and some output.
Passing Formatted Text Through XSLT