The role of Notch signaling during skin development was analyzed using Msx2-Cre to create mosaic loss-of-function alleles with precise temporal and spatial resolution. We find that gamma-secretase is not involved in skin patterning or cell fate acquisition within the hair follicle. In its absence, however, inner root sheath cells fail to maintain their fates and by the end of the first growth phase, the epidermal differentiation program is activated in outer root sheath cells. This results in complete conversion of hair follicles to epidermal cysts that bears a striking resemblance to Nevus Comedonicus. Sebaceous glands also fail to form in gamma-secretase-deficient mice. Importantly, mice with compound loss of Notch genes in their skin phenocopy loss of gamma-secretase in all three lineages, demonstrating that Notch proteolysis accounts for the major signaling function of this enzyme in this organ and that both autonomous and nonautonomous Notch-dependent signals are involved.