I agree with how Gale did it, except I think they used 10.5" strips, not 12.5" in the picture. This is a convenient length as well, as you should be able to get 4 strips from the width of your fabric (or a jelly roll strip).
To align the rail fence part and the square part, see how in the lower right-hand corner of the picture, there is a little set of 3 squares below the first square-in-square? This is a 2.5" strip of one of the big rail fence strip sets. Attach it below the first square-in-square, and then everything should line up. I hope that makes sense!