This is where the "Doing a Clean install with an Upgrade disc" workaround comes into play..
Since directly Upgrading from Windows XP to Windows 7 isn't really a good option for multiple reasons.. Doing a clean install is the way to go..
I always recommend a clean install over an upgrade anyway just because it is 99% of the time much easier and leaves you with a good fresh install...
That being said there are a couple of different ways you could do this..
The first being to install as normal using your Windows 7 Upgrade media, the installation will search for a previous version of Windows.. If you have a previous (qualifying) version of Windows installed (and it's legit of course
) then the installation will continue as normal..
The second being the workaround.. Which is a fancy way of saying that you can use the Upgrade media to perform a clean install without having any previous versions of Windows already installed.. So a blank HDD in other words.. The catch to this trick is you may have to physically install Windows 7 twice.. Reason being, you have an Upgrade key, so in order to activate this key you need to have an Upgrade installation..
There are guides posted on this forum that explain exactly how to perform this trick.. There are also various guides online that explain a couple of different methods to perform this trick..
The easiest method (in my opinion) is to insert your Windows 7 DVD and boot from it as normal. Proceed with the installation as you normally would but when you get to the screen that gives you the option to pick a Clean Install or Upgrade, choose Clean Install. The next screen gives you the option to format, create/remove partitions. After you have finished setting up your partitions continue with the installation as normal. Once it has finished DO NOT ATTEMPT TO ACTIVATE! Go to Windows Updates and install all available Windows Updates as well as any driver updates that may be available to you.. Once finished, reboot and boot off of the Windows 7 installation DVD again.
Proceed as normal but this time choose Upgrade install rather than Clean install. The installation will continue.. Since this is the Upgrade install, it usually takes a little longer to complete. This is normal so don't be alarmed. Once this installation has finished you can now activate it using your product key.
I have included a link to a guide that explains this trick in a little more detail.
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I wish you luck with your installation and please don't hesitate to ask for help should you run into any problems during the process..