In utero hematopoietic stem cell transplantation (IUT) results in limited chimerism and tolerance to alloantigens. We studied the relative role of B7.1 and B7.2 expression by dendritic cells (DCs) in engraftment and in generating donor-specific tolerance in fetal mice. Mature dendritic cells (mDCs) from B7.1(-/-) or B7.2(-/-) donors and wild-type (WT) lineage-depleted (lin(-)) C57BL/6 (B6) bone marrow (BM) were injected into BALB/c fetuses. Six weeks after IUT, B7.1(-/-) recipients had multilineage engraftment (4.7% +/- 0.8% T cells and 5.7% +/- 1.1% granulocytes) associated with graft-versus-host disease (GVHD) and decreased survival, but by 12 weeks only donor CD3(+) cells (2.1% +/- 1.3%) were present. Recipients of B7.2(-/-) mDCs and lin(-) WT B6 BM had exclusively CD3(+)CD4(+) T cells (11.8% +/- 8.5% at 6 weeks and 6.5% +/- 2.5% at 12 weeks). Most of the cells were T-helper 2, although 10.4% +/- 1.4% were of the T-regulatory (T(reg)) phenotype, ie, CD4(+)CD25(+). Donor T(reg) cells were detected both in the thymus and spleen, thus suggesting an effect on both central and peripheral immunity. The animals with T(reg) cells had better survival (82.3% versus 47.4%; P < .01) and no GVHD (0% versus 65%; P < .001). This group alone demonstrated multilineage engraftment of donor hematopoietic cells after postnatal transplantation with megadoses of donor lin(-) BM. Both the engrafted donor CD4(+)CD25(-) and CD4(+)CD25(+) cells induced comparable in vitro suppression of T-cell proliferation, thus suggesting their role in the persistence of the donor T cells in vivo. The CD4(+)CD25(-) cells produced interleukin 10 or interleukin 4 and were inhibited by anti-T-helper 2 cytokine-neutralizing antibodies, whereas the CD4(+)CD25(+) cells showed no evidence of any involvement of a cytokine-like soluble mediator and expressed cytotoxic T-lymphocyte antigen 4 (CTLA-4) and foxp3 constitutively. Donor mDCs and donor CD4 T cells were detected among the thymocytes of the recipients of B7.2(-/-) mDCs and lin(-) WT B6 BM. Thus, it seems that costimulatory molecule expression of donor DCs can play a significant immunomodulatory role in survival, GVHD, engraftment, and homing of allogeneic BM cells after IUT through the generation of T(reg) cells.