Thanks to all that responded, I was a little worried about chmoding any foldres to 777, but with only
and this WORKED.
1. I upgraded wordpress to 2.6
2. I put the uploads folderīs chmod to 777 (.../wp-content/
uploads/...)
3. I set the custom URL Settings back to default (I had checked this box before, to create by month and day)
(You find this through site admin > Settings > Permalinks > Common settings )
4. I unchecked the "Organize my uploads into month- and year-based folders" located in (You find this through site admin > Settings > uplaoding > Miscellaneous )
And uploaded beautifully!.
Again, thank you all!