The t(2;13) translocation of alveolar rhabdomyosarcoma results in tumor-specific expression of a chimeric transcription factor containing the N-terminal DNA-binding domain of PAX3 and the C-terminal transactivation domain of FKHR. Here we have tested the hypothesis that PAX3-FKHR gains function relative to PAX3 as a consequence of switching PAX3 and FKHR transactivation domains, which were previously shown to have similar potency but distinct structural motifs. In transient cotransfection assays with human expression constructs, we have demonstrated the increased ability of PAX3-FKHR to activate transcription of a reporter gene located downstream of multimerized e5, PRS-9, or CD19 DNA-binding sites in three cell lines. For example, PAX3-FKHR was 100-fold more potent than PAX3 as an activator binding to e5 sites in NIH 3T3 cells. To compare transactivation potency independent of PAX3-specific DNA binding, we tested GAL4 fusions of full-length PAX3 and PAX3-FKHR or their respective C-terminal transactivation domains on a reporter with GAL4 DNA-binding sites. In this context, full-length PAX3-FKHR was also much more potent than PAX3. Additionally, the activity of each full-length protein was decreased relative to its C-terminal domain, demonstrating that N-terminal sequences are inhibitory. By deletion analysis, we mapped a bipartite cis-acting inhibitory domain to the same subregions within the DNA-binding domains of both PAX3 and PAX3-FKHR. We have shown, however, that the structurally distinct transactivation domains of PAX3 and PAX3-FKHR differ 10- to 100-fold in their susceptibility to inhibition, thus elucidating a mechanism by which PAX3 gains enhanced function during oncogenesis.