Hedgehog (HH) signaling proteins mediate inductive events during animal development. Mutation of the only known HH receptor gene, Patched (PTC), has recently been implicated in inherited and sporadic forms of the most common human cancer, basal cell carcinoma (BCC). In Drosophila, HH acts by inactivating PTC function, raising the possibility that overexpression of Sonic Hedgehog (SHH) in human epidermis might have a tumorigenic effect equivalent to loss of PTC function. We used retroviral transduction of normal human keratinocytes to constitutively express SHH. SHH-expressing cells demonstrated increased expression of both the known HH target, BMP-2B, as well as bcl-2, a protein prominently expressed by keratinocytes in BCCs. These keratinocytes were then used to regenerate human skin transgenic for long terminal repeat-driven SHH (LTR-SHH) on immune-deficient mice. LTR-SHH human skin consistently displays the abnormal specific histologic features seen in BCCs, including downgrowth of epithelial buds into the dermis, basal cell palisading and separation of epidermis from the underlying dermis. In addition, LTR-SHH skin displays the gene expression abnormalities previously described for human BCCs, including decreased BP180/BPAG2 and laminin 5 adhesion proteins and expression of basal epidermal keratins. These data indicate that expression of SHH in human skin recapitulates features of human BCC in vivo, suggest that activation of this conserved signaling pathway contributes to the development of epithelial neoplasia and describe a new transgenic human tissue model of neoplasia.