The differentiation of uncommitted mesenchymal cells into osteoblasts is a fundamental molecular event governing both embryonic development and bone repair. The bone morphogenetic proteins (BMPs) are important regulators of this process; they function by binding to cell surface receptors and signaling by means of Smad proteins. Core binding factor alpha-1 (Cbfa1), a member of the runt family of transcription factors, is an essential transcriptional regulator of osteoblast differentiation and bone formation, and this process is positively or negatively regulated by a variety of coactivators and corepressors. We report that p204, an interferon-inducible protein that was previously shown to inhibit cell proliferation and promote the differentiation of myoblasts to myotubes, is a novel regulator in the course of osteogenesis. p204 is expressed in embryonic osteoblasts and hypertrophic chondrocytes in the growth plate as well as in the calvaria osteoblasts of neonatal mice. Its level is increased in the course of the BMP-2-triggered osteoblast differentiation of pluripotent C2C12 cells. This increase is probably due to the activation of the gene encoding 204 (Ifi204) by Smad transcription factor, including Smad1, -4, and -5. Overexpression of p204 enhances the BMP-2-induced osteoblast differentiation in vitro, as revealed by elevated alkaline phosphatase activity and osteocalcin production. p204 acts as a cofactor of Cbfa1: 1) high levels of p204 augment, whereas the lowering of p204 level decreases, the Cbfa1-dependent transcription, and 2) p204 associates with Cbfa1 both in vitro and in vivo. Two nonoverlapping segments in p204 bind to Cbfa1, and the N-terminal 88-amino acid segment of Cbfa1 is required for binding to p204. p204, which is the first interferon-inducible protein found to associate with Cbfa1, functions as a novel regulator of osteoblast differentiation.