i was reformatting my sisters comp a couple weeks ago and ran across this problem. while xp was loaded i put in the xp cd and told it to install. it began copying setup files to the harddrive and then rebooted and took me to the partition screen to decide where to install. i too, wanted to delete the partition but i wouldn't let me for the same reason you got.
so i told it to reboot and after posting i hit the button to take me into the startup options (might've been f1 on her dell). i chose to boot from cd in there and then it let me delete the partition and install. so try that.