This post guide you through on “how to go from having Windows XP installed to having Windows 7 installed in the primary partition with Windows XP encapsulated into a VHD?”. 

1. Boot from Windows 7 fron a USB Key; Run some diskpart magic wrapped up in a script to calculate the values shrink-and-clone-to-another-volume

> diskpart
select disk 0
select volume 1
Shrink desired=28500 (where 28500 is ~15% larger than the data on the harddisk)

create partition primary
format fs=ntfs label=VHD quick
assign

Create vdisk file=E:\WINXP.VHD maximum=79999 (where 79999 is the size of the original physical disk)
Select vdisk file=E:\WinXP.VHD
attatch vdisk
create parition primary
format fs=ntfs label=WinXPVHD quick

1. clone Windows XP into the VHD (tossing around the best tool for this;  robocopy is inbuilt, but not ideal)
2. format the old C: and install Win7 to physical disk
3. Move out the VHD and collapse the last partition

Setup the Offline domain join, and tweak the setup a bit more with the updated  WAIK.

Source:→ Dugie