A standard roleplaying environment: the tavern. This is another easy one to create in your own home, providing you have a large enough group of roleplaying friends. Let us assume your PC group is no larger than five, and that the rest of your friends can be NPCs. Let us also aim for an exceptionally seedy and unscrupulous city tavern.
In a good LARP it is desirable to separate the players out individually at some stage, because they are more suggestible and afraid when they are alone. Some form of individual challenge is probably the best way of doing this. One possible setting for this is a cave system, and it is probably one of the easiest to recreate realistically, and one of the most perfect for playing on fears of claustrophobia and darkness.
Once a year, the king steps down from his throne, and lives as a peasant for one day, the next day is the anniversary of his coronation, and it is celebrated by a reenactment of the ceremony. This is doubly beneficial, firstly, because the people are able to have the grand parade that always precedes the ceremony. Secondly, because the heir to the throne is given a day on the job every year. Although, apparently, the thought has not yet come to one of the kingdoms enemies, the assassination of the king during the renewal coronation would be a moral, as well as a political blow to the kingdom.