During Drosophila visual system development, photoreceptors R7 and R8 project axons to targets in distinct layers of the optic lobe. We show here that the LAR receptor tyrosine phosphatase is required in the eye for correct targeting of R7 axons. In LAR mutants, R7 axons initially project to their correct target layer, but then retract to the R8 target layer. This targeting defect can be fully rescued by transgenic expression of LAR in R7, and partially rescued by expression of LAR in R8. The phosphatase domains of LAR are required for its activity in R7, but not in R8. These data suggest that LAR can act both as a receptor in R7, and as a ligand provided by R8. Genetic interactions implicate both Enabled and Trio in LAR signal transduction.