The difference is in how web.config properties are inherited from parent application.
If Virtual Directory in IIS 6.0 is physically located outside of parent web application, then web.config properties are not inherited. Even if logically Virtual Directory is inside parent web application.
So, even if from end user URL looks like this:
http://www.parentwebapp.com/virtualdirectory -- virtualdirectory web app does not inherit web.config properties from parentwebapp.com
IIS 7.0 is smarter than IIS 6.0.
Even if parentwebapp.com and virtualdirectory from above example are mapped to different physical folders like this:
http://www.parentwebapp.com/ -- c:\parentwebapp
http://www.parentwebapp.com/virtualdirectory/ -- c:\virtualdirectory
IIS 7.0 still recognizes that http://www.parentwebapp.com/virtualdirectory/ inherits all web.config settings from http://www.parentwebapp.com/
Such inheritance sometimes causes undesired effects.
For example, if you added HttpModules to parent web app code, but didn't add them to child virtual directory, you may end up with "Could not load type ..." run-time error.
In order to get rid of this error you need from inherited settings.
You can do it like this:
<remove name="DenyIpAddressModule" />
Note, that in this example I remove "DenyIpAddressModule" twice.
The reason for that is that I added "DenyIpAddressModule" module to parent web.config twice: once as regular httpmodule, and another time as integrated pipeline module.