It sounds like you want a clean install, using MS's W7 up grade for XP. You do that by loading the CD, and on the intro screen, select "Custom install" in the lower left-hand corner of the screen. You may also wish to install without the CD key - you can enter the key after you install W7 to activate your installation after you have it tweaked.
Boot with the W7 disk and choose custom as treefrog said.
When you use the custom install option that gives you the option to use the disk tools to format, create and delete partitions.
The validation is done during the boot process, so don't try to format before running W7 setup.