To assess whether Smad signaling affects skin development, we generated transgenic mice in which a Smad antagonist, Smad7, was induced in keratinocytes, including epidermal stem cells. Smad7 transgene induction perturbed hair follicle morphogenesis and differentiation, but accelerated sebaceous gland morphogenesis. Further analysis revealed that independent of its role in anti-Smad signaling, Smad7 bound beta-catenin and induced beta-catenin degradation by recruiting an E3 ligase, Smurf2, to the Smad7/beta-catenin complex. Consequently, Wnt/beta-catenin signaling was suppressed in Smad7 transgenic hair follicles. Coexpression of the Smurf2 and Smad7 transgenes exacerbated Smad7-induced abnormalities in hair follicles and sebaceous glands. Conversely, when endogenous Smad7 was knocked down, keratinocytes exhibited increased beta-catenin protein and enhanced Wnt signaling. Our data reveal a mechanism for Smad7 in antagonizing Wnt/beta-catenin signaling, thereby shifting the skin differentiation program from forming hair follicles to sebaceous glands.