HIV-1 nucleocapsid protein (NC) is a nucleic acid chaperone, which is required for highly specific and efficient reverse transcription. Here, we demonstrate that local structure of acceptor RNA at a potential nucleation site, rather than overall thermodynamic stability, is a critical determinant for the minus-strand transfer step (annealing of acceptor RNA to (-) strong-stop DNA followed by reverse transcriptase (RT)-catalyzed DNA extension). In our system, destabilization of a stem-loop structure at the 5' end of the transactivation response element (TAR) in a 70-nt RNA acceptor (RNA 70) appears to be the major nucleation pathway. Using a mutational approach, we show that when the acceptor has a weak local structure, NC has little or no effect. In this case, the efficiencies of both annealing and strand transfer reactions are similar. However, when NC is required to destabilize local structure in acceptor RNA, the efficiency of annealing is significantly higher than that of strand transfer. Consistent with this result, we find that Mg2+ (required for RT activity) inhibits NC-catalyzed annealing. This suggests that Mg2+ competes with NC for binding to the nucleic acid substrates. Collectively, our findings provide new insights into the mechanism of NC-dependent and -independent minus-strand transfer.