I haven't managed to successfully do this yet, but it is theoretically possible. I have thought of using a photo to cross stitch program to design a watercolor quilt of a sunset over the water. I haven't figured out how to get the resolution right to get a decent conversion.
There are some books about doing landscapes, and photos by applique. They involve tracing the photo and tracing changes in color.
I'm curious about the same thing, since I'd like to make an applique of my black cat, something other than just a silhouette.