First, it's a 404, not a 500. ;-) That's a big difference.
One of the limitations with subdomain installs using mod_rewrite is that you [b]must choose between a folder and a subdomain access[/b]. You can have one, but not both.
To fix it, just make your .htaccess say `RewriteBase /` for the subdomain to work.
If you absolutely must access both, you can turn the mod_rewrite option off in config.php.
I think it actually makes sense this way, since that path actually doesn't exist in the subdomain ;-)
Someday I'll find out how to get rid of this RewriteBase stuff once and for all...