The following worked for me, but keep in mind that the issue is still in the form of several bugs, that were not yet addressed as of v. 7.14. It involves something with bootstrap.inc, and updated .htaccess between v. 6 and v. 7. I do not fully grasp modRewrite syntax, so particular instructions could be not as efficient. I just used what worked for me (at godaddy.com hosting).

1. Place Drupal installation in /drupal/ directory (or whichever, adjust accordingly).

2. Set $base_url in config.php to your domain ($base_url = 'http://example.net';).

3. Create .htaccess file in the root directory and place following in it:

    # Don't show directory listings for URLs which map to a directory.
    Options -Indexes
   
    # Follow symbolic links in this directory.
    Options +FollowSymLinks
   
    ReWriteEngine On
    ReWriteBase /
   
    # Exclude other directories from rewrite rules
    RewriteRule ^(exclude1|exclude2) - [L]
   
    RewriteCond %{HTTP_HOST} ^example\.net$ [NC]
    ReWriteRule !^drupal/   - [C]
    ReWriteRule ^(.*)  drupal/$1  [L]
   

   Note: Up to this point, instructions work the same for Drupal 6 (it would be complete now).

4. In the /drupal/.htaccess file find the section starting with following comments:

    # Pass all requests not referring directly to files in the filesystem to
    # index.php. Clean URLs are handled in drupal_environment_initialize().
   

   Comment out this string (to keep it in case the issue shall be fixed):

    RewriteRule ^ index.php [L]
   

   And add following line (from drupal 6):

    RewriteRule ^(.*)$ index.php?q=$1 [L,QSA]
   

The following worked for me, but keep in mind that the issue is still in the form of several bugs, that were not yet addressed as of v. 7.14. It involves something with bootstrap.inc, and updated .htaccess between v. 6 and v. 7. I do not fully grasp modRewrite syntax, so particular instructions could be not as efficient. I just used what worked for me (at godaddy.com hosting).

1. Place Drupal installation in /drupal/ directory (or whichever, adjust accordingly).

2. Set $base_url in settings.php to your domain ($base_url = 'http://example.net';).

3. Create .htaccess file in the root directory and place following in it:

    # Don't show directory listings for URLs which map to a directory.
    Options -Indexes
   
    # Follow symbolic links in this directory.
    Options +FollowSymLinks
   
    ReWriteEngine On
    ReWriteBase /
   
    # Exclude other directories from rewrite rules
    RewriteRule ^(exclude1|exclude2) - [L]
   
    RewriteCond %{HTTP_HOST} ^example\.net$ [NC]
    ReWriteRule !^drupal/   - [C]
    ReWriteRule ^(.*)  drupal/$1  [L]
   

   Note: Up to this point, instructions work the same for Drupal 6 (it would be complete now).

4. In the /drupal/.htaccess file find the section starting with following comments:

    # Pass all requests not referring directly to files in the filesystem to
    # index.php. Clean URLs are handled in drupal_environment_initialize().
   

   Comment out this string (to keep it in case the issue shall be fixed):

    RewriteRule ^ index.php [L]
   

   And add following line (from drupal 6):

    RewriteRule ^(.*)$ index.php?q=$1 [L,QSA]