CyberSprocket.com
public text v1 · immutablelook at this...
http://www.hoozh.net/2006/09/25/mod_rewrite-and-http-auth-with-htaccess/
It has the answer of why basic auth breaks in this setup.
Need 2 things...
1) add this to the httpd.conf
ErrorDocument 401 /unauthorized.html
2) go create the unauthorized.html file.