Bone-marrow-derived mesenchymal stem cells (MSCs) have been shown to possess immunosuppressive properties, e.g., by inhibiting T cell proliferation. Activated T cells can also enhance the immunosuppression ability of MSCs. The precise mechanisms underlying MSC-mediated immunosuppression remain largely undefined, although both cell-cell contact and soluble factors have been implicated; nor is it clear how the immunosuppressive property of MSCs is modulated by T cells. Using MSCs isolated from mouse bone marrow, we show here that interferon gamma (IFNgamma), a well-known proinflammatory cytokine produced by activated T cells, plays an important role in priming the immunosuppressive property of MSCs. Mechanistically, IFNgamma acts directly on MSCs and leads to up-regulation of B7-H1, an inhibitory surface molecule in these stem cells. MSCs primed by activated T cells derived from IFNgamma-/- mouse exhibited dramatically reduced ability to suppress T cell proliferation, a defect that can be rescued by supplying exogenous IFNgamma. Moreover, siRNA-mediated knockdown of B7-H1 in MSCs abolished immunosuppression by these cells. Taken together, our results suggest that IFNgamma plays a critical role in triggering the immunosuppresion by MSCs through up-regulating B7-H1 in these cells, and provide evidence supporting the cell-cell contact mechanism in MSC-mediated immunosuppression.