Source:
http://www.maximumpc.com/article/fea...tions_answered
The Upgrade version of Windows 7 does require a
pre-existing VALIDATED installation of Windows XP or Vista. This means that you first need to install XP or Vista, validate it online, and THEN install Windows 7. You CANNOT simply "insert a CD" of a previous copy of Windows. This was available in Windows XP upgrades, but NOT in Windows 7. You CANNOT simply choose to "enter a Product Key at a later date." This was available in Vista, but NOT in Windows 7.
So again, the ONLY way to use the Windows 7 Upgrade is to have a
pre-existing and VALIDATED installation of Windows XP or Vista. Yes, you need to go through the install process for two OS'es (first Win XP/Vista, then Win7). Yes, this is a colossal pain in the arse. No, there is no way around it.
If you are upgrading from XP, your only option after the installer detects your validated XP install is to wipe out XP, and do a clean-install. If you are upgrading from Vista, your options are to do either an in-place upgrade, or a clean-install where all of your data gets wiped out.
Once you upgrade, your old XP / Vista product key will be DEACTIVATED. So do not use any XP or Vista product key that you plan on using again. The product key will be rejected when you attempt to authorize online.
Technically, this is incorrect. Giving someone a copy still counts as making and distributing an unauthorized copy, even if it still requires a product key. Most software companies won't go after you, since you did buy a legitimate copy and are only using your legitimate copy. But in the eyes of the law, this is *NOT* legal.