AN SMA ON A PRACTICE APCH CONFLICTED WITH AN SMA THAT WAS IFR. ALTDEV ALT EXCURSION DURING PRACTICE INST APCH.

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I WAS FLYING A TWIN COMANCHE WITH MY STUDENT SEEKING A MULTI-ENG RATING. WE PLANNED TO MAKE AN ILS APCH TO FULL STOP WITH 1 ENG INOP (SIMULATED). WE REQUESTED A PRACTICE APCH SINCE THE CONDITIONS WERE VFR AT THE TIME. AFTER WE CONTACTED DEP; WE WERE TOLD THAT ILS WAS NOT AVAILABLE AND WERE OFFERED AN NDB WHICH WE ACCEPTED. WE LEVELED OFF AT 2000 FT. WHEN WE WERE CLRED FOR THE FINAL APCH I SIMULATED AN ENG FAILURE. THE STUDENT ALIGNED HIMSELF FINE BUT HAD DIFFICULTY MAINTAINING ALT. WHEN HE DSNDED BELOW MDA (1700 FT); I DECIDED TO GIVE HIM BACK THE ENG AND LET HIM JUST FLY THE APCH (ON BOTH ENGS). THE STUDENT STARTED CLBING BACK TO 2000 FT. THE CTLR ADVISED US ABOUT CESSNA TFC AND I STARTED LOOKING. AFTER A WHILE I RPTED THAT TFC WAS IN SIGHT. THE CESSNA WAS TO OUR L AND AHEAD OF US AT ABOUT 3000 FT PASSING TO OUR R. THE CESSNA AND OUR ACFT WERE IN VFR CONDITIONS. THE STUDENT; HOWEVER; CLBED TO APPROX 2200 FT. BEFORE DSNDING THROUGH A THIN CLOUD LAYER THAT HAD JUST FORMED; I ASKED THE TWR TO VERIFY THAT WE COULD DSND SINCE BOTH OF US WERE UNDER THE IMPRESSION THAT WE WERE MAKING A PRACTICE (VFR) APCH. AFTER OUR FLT WE WERE TOLD TO CALL THE TWR SUPVR AND WERE ADVISED THAT ACCORDING TO THEIR COMPUTER; THE VERT SEPARATION FROM THE OTHER CESSNA WAS 700 FT AT ONE MOMENT; SINCE WE CLBED TO 2300 FT. I SAID THAT WE RPTED THE CESSNA IN SIGHT WHICH THE CTLR LATER CONFIRMED. WE WERE NEVER AWARE THAT THE CESSNA WAS IFR. IN ANY CASE; I SHOULD HAVE VERIFIED THAT WE WERE MAKING A PRACTICE APCH AND NOT ASSUME THAT IN VFR CONDITIONS; I DO NOT HAVE TO PAY CLOSE ATTN TO OUR ALT.