Just thought I'd post this article to stop all those poor developers trawling through hundreds of pages on Google like I had to, to work out why on Earth I kept on getting the error below.
The property 'SharedLegacyFile' must be TRUE for isolated file 'File Name'
Let me guess the answer you get to this response. is that you have to set the SharedLegacyFile setting to True in VSI File System explorer for the file you were trying to add to the application folder and even when you did this it still didn't resolve the issue right? Well the error message is misleading.
Solution
Basically if you rename your DLL or EXE that has been effected to say myfile.DLLX or Myfile.EXEX so VSI doesn't recognise it as an executable and then compile. The VSI project will compile successfully then rename the files back to EXE or DLL and compile again and the problem is solved.
Hope this helps you out, hopefully I'll work out why it does it this way...