My take

The standard interpretation of this film is that roughly the first 2/3's of the film is a dream, the main protagonist wakes up, then we see reality.

But what I think is this . . .

In Lynch's next film, Inland Empire, there is a scene where Piotrek enters a room where a seance is underway. Sitting around the table are the participants and the spirit they've summoned, a girl. The girl is speaking to Piotrek, but when asked, he replies that he doesn't see her, but does hear her.

Cut.

I believe that scene perfectly exemplifies what we are seeing throughout MD.

And it all starts with Aunt Ruth.

In the beginning of the film as she is standing next to the taxi, we are looking at her as we hear footsteps running up the steps toward Aunt Ruth's vacated residence. Ruth looks up, looks toward the sound of the footsteps, then the camera cuts to Rita running up the steps, then back to Ruth. But Ruth isn't looking at the person running toward her unit any longer, Ruth is looking downward with a curious look on her face. I think it's a fair conclusion that Ruth doesn't see Rita. How could this be? She was looking right at her! Had she seen her she surely would have reacted to someone entering her unit. The fact that she didn't see her is further evidenced when Ruth goes back to her unit to retrieve a key she forgot. She doesn't seek out the girl, that we, the audience, just saw run into the place.

So later in the film we get Rita disappearing into a box and see/hear a loud thump as it hits the bedroom floor. Ruth comes to investigate the sound. She heard it. But the camera pans to show us that there's nothing on the floor. Once again, Ruth hears something but doesn't see it. Just like Piotrek in IE.

So my interpretation is that what we see in the beginning -- the jitterbug contest -- is in Diane's head. That is made obvious when the POV shot has a fuzzy image of Betty and the old couple that we've just seen superimposed over the jitterbug contest. With the POV shot we are in reality. Her head hits the pillow and she dies (the purple in the background indicates this but I won't go into that right now - see Twin Peaks season 3 Episode 3 for when Cooper plunges into the purple).

Then we see the limo snaking along MD, followed by the botched hit and the car crash. That is real also. Only Camilla dies in the car crash. What we are seeing is her spirit stumbling down to Sunset Blvd (get it?). There her spirit is heard by some but not seen. Dianne (Betty) arrives descending at the airport and finds Camilla at Ruth's place. She's dead too. Obviously the two do not know that they're dead, but they come to realize this at Club Silencio later.

I think the brief scene with Louise Bonner is key also. Louise appears to be a spiritist of some sort, who can see both worlds. Hence her confusion over Dianne calling herself Betty and that other person she saw in her room that she wants out (she wants out NOW!).

Back to the box hitting the floor. After Ruth leaves the camera juxtaposes two dwellings occupying the same space. In one is Ruth, in the other is Dianne. The Cowboy sees both worlds. In one Dianne is alive, in the other she is dead. Everything we see after Dianne wakes is reality. It's backstory to fill us in, yes, but it all happened. At the end Dianne kills herself.

I think we are seeing a bardo thiol unfolding. That has been suggested by others before and I agree. I think Twin Peaks and LOST do the same. The characters we are watching are all dead, just repeating iterations of their lives until they are ready to pass on.

Thumbnail sketch, but that's my take. So I don't think the film is as cut-and-dry as "it was all a dream until the ending." That explanation always felt a bit lumpy under the surface to me. But who knows, maybe next time I watch the film I'll have different thoughts. That's one of the beauties of this film.