Hepatocyte nuclear factor-1beta (HNF-1beta) is a homeodomain-containing transcription factor that regulates tissue-specific gene expression in the kidney and other epithelial organs. Mutations of HNF-1beta produce congenital cystic abnormalities of the kidney, and previous studies showed that HNF-1beta regulates the expression of the autosomal recessive polycystic kidney disease (ARPKD) gene, Pkhd1. Here we show that the C-terminal region of HNF-1beta contains an activation domain that is functional when fused to a heterologous DNA-binding domain. An HNF-1beta deletion mutant lacking the C-terminal domain interacts with wild-type HNF-1beta, binds DNA, and functions as a dominant-negative inhibitor of a chromosomally integrated Pkhd1 promoter. The activation of the Pkhd1 promoter by wild-type HNF-1beta is stimulated by sodium butyrate or coactivators CREB (cAMP-response element)-binding protein (CBP) and P/CAF. The interaction with CBP and P/CAF requires the C-terminal domain. Expression of an HNF-1beta C-terminal deletion mutant in transgenic mice produces renal cysts, increased cell proliferation, and dilatation of the ureter similar to mice with kidney-specific inactivation of HNF-1beta. Pkhd1 expression is inhibited in cystic collecting ducts but not in non-cystic proximal tubules, despite transgene expression in this nephron segment. We conclude that the C-terminal domain of HNF-1beta is required for the activation of the Pkhd1 promoter. Deletion mutants lacking the C-terminal domain function as dominant-negative mutants, possibly by preventing the recruitment of histone acetylases to the promoter. Cyst formation correlates with inhibition of Pkhd1 expression, which argues that mutations of HNF-1beta produce kidney cysts by down-regulating the ARPKD gene, Pkhd1. Expression of HNF-1alpha in proximal tubules may protect against cystogenesis.