Signal transduction specificity in the transforming growth factor-beta (TGF-beta) system is determined by ligand activation of a receptor complex which then recruits and phosphorylates a subset of SMAD proteins including Smads 1 and 2. These then associate with Smad4 and move into the nucleus where they regulate transcription. We have identified a discrete surface structure in Smads 1 and 2 that mediates and specifies their receptor interactions. This structure is the L3 loop, a 17 amino acid region that protrudes from the core of the conserved SMAD C-terminal domain. The L3 loop sequence is invariant among TGF-beta- and bone morphogenetic protein (BMP)-activated SMADS, but differs at two positions between these two groups. Swapping these two amino acids in Smads 1 and 2 induces a gain or loss, respectively, in their ability to associate with the TGF-beta receptor complex and causes a switch in the phosphorylation of Smads 1 and 2 by the BMP and TGF-beta receptors, respectively. A full switch in phosphorylation and activation of Smads 1 and 2 is obtained by swapping both these two amino acids and four amino acids near the C-terminal receptor phosphorylation sites. These studies identify the L3 loop as a determinant of specific SMAD-receptor interactions, and indicate that the L3 loop, together with the C-terminal tail, specifies SMAD activation.