Thank you for replying back to us! Happy to assist you further!
I have investigated more on your ask and the suggestion is that it is not supported to create an image from a VM that is encrypted. You need ALWAYS decrypt the VM that you want to use as image.
Snapshots in Azure retain the encryption settings of the original OS disk. This means that if the OS disk was encrypted using Azure Disk Encryption or other encryption methods, the snapshot will also be encrypted with the same settings.
To deploy a new VM from an encrypted VM using snapshots, you typically follow these steps:
Create a Snapshot of the Encrypted OS Disk and Create a Managed Disk from the Snapshot. The managed disk will retain the ADE encryption, including references to the same Key Vault and encryption keys.
Create a VM from the Managed Disk
When creating the new VM, use the managed disk as the OS disk.
You don’t need to re-enable ADE manually unless:
You move to a different subscription or region.
You change the encryption type (e.g., from ADE to disk encryption set).
If the original VM was encrypted, you may need to configure the encryption settings for the new VM, such as providing encryption keys or passwords. You can also disable ADE here like below.
Similar issue: https://stackoverflow.com/questions/56454966/azure-os-disk-encryption-on-vm-creation
Hope this clarifies!