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In order to use IIS Isolation properly you must create the following folder structure http://www.iis.net/learn/publish/using-the-ftp-service/configuring-ftp-user-isolation-in-iis-7

User Account Types Physical Home Directory Syntax
Anonymous users %FtpRoot%\LocalUser\Public
Local Windows user accounts (requires basic authentication) %FtpRoot%\LocalUser\%UserName%
Windows domain accounts (requires basic authentication) %FtpRoot%\%UserDomain%\%UserName%
IIS Manager or ASP.NET custom authentication user accounts %FtpRoot%\LocalUser\%UserName%

(Note: In the above table, %FtpRoot% is the root directory for your FTP site; for example, C:\Inetpub\Ftproot.)