Anyone else know anything about this? I'm not home so I can't look at one of my XP disks. I can't remember right now if its XP or XP w/SP1. I know I did just upgrade it directly to SP3. I don't know why you can't do it directly.
Just proceed with the installation. Load the service pack to SP3 or whatever is the latest from Microsoft(SP3).
After that you can use a drive-too such as acronis disk director or Partition Magic-8 to repartition the drive or resize the partition of the drive. It will enable you to use the remainder of the disk as one whole 750gb or you can create separate partition for OS and Data.
To make XP work with disks larger than 128GiB (but smaller than 2TiB) you only need Service Pack 1, not SP2 or SP3 they don't affect this issue.
So only XP without any service pack will be limited to 128GiB. So you have two options:
You can install on a partition smaller than 128GiB, once installed and running you run the SP1/SP2 setup; reboot and windows will detect the full capacity of the disk. Still you are left with a 128GiB partition. You can then either expand this partition, or make a second (non-boot) partition.
You can slipstream Windows XP so the CD has SP1/SP2/SP3 integrated already, meaning you can partition up to 2 Terabytes from within the Windows Setup; so you can instantly create one big partition if that's what you want; without having to change anything after installation.