See this thread: http://social.microsoft.com/Forums/en-US/LiveMesh/thread/de97cae2-1ab6-481c-be9d-311dff79b8f7/?ffpr=0 for more details, but the simple solution is…
Right click the website folder, choose the customize tab, and change the icon back to a normal folder icon. That’s it. Your website will still work as such, but now it will sync too 🙂