Megalin is a low-density lipoprotein receptor-related protein (LRP2) expressed in the neuroepithelium and the yolk sac of the early embryo. Absence of megalin expression in knockout mice results in holoprosencephaly, indicating an essential yet unidentified function in forebrain development. We used mice with complete or conditional megalin gene inactivation in the embryo to demonstrate that expression of megalin in the neuroepithelium but not in the yolk sac is crucial for brain development. During early forebrain development, megalin deficiency leads to an increase in bone morphogenic protein (Bmp) 4 expression and signaling in the rostral dorsal neuroepithelium, and a subsequent loss of sonic hedgehog (Shh) expression in the ventral forebrain. As a consequence of absent SHH activity, ventrally derived oligodendroglial and interneuronal cell populations are lost in the forebrain of megalin-/- embryos. Similar defects are seen in models with enhanced signaling through BMPs, central regulators of neural tube patterning. Because megalin mediates endocytic uptake and degradation of BMP4, these findings indicate a role for megalin in neural tube specification, possibly by acting as BMP4 clearance receptor in the neuroepithelium.