Lmx1b, a member of the LIM homeodomain protein family, is essential for the specification of dorsal limb fates at the zeugopodal and autopodal level in vertebrates. We and others have shown that a skeletal dysplasia, nail–patella syndrome (NPS), results from mutations in LMX1B. While it is a unique mesenchymal determinant of dorsal limb patterning during vertebrate development, the mechanism by which LMX1B mutations generate the NPS phenotype has not been addressed at a transcriptional level or correlated with its spatial pattern of gene expression. In this study, in situ hybridizations of Lmx1b on murine limb sections reveal strong expression in dorsal mesenchymal tissues (precursors of muscle, tendons, joints and patella) and, interestingly, also in anterior structures of the limb, explaining the anterior to posterior gradient of joint and nail dysplasia observed in NPS patients. Transfection studies showed that both the LIM domain-interacting protein, LDB1, and the helix–loop–helix protein, E47/shPan1, can regulate LMX1B action. While co-transfections of E47/shPan1 with LMX1B result in a synergistic effect on reporter activity, LDB1 down-regulated LMX1B-mediated transactivation irrespective of E47/shPan1. Mutant LMX1B proteins containing human mutations affecting each of the helices or the N-terminal arm of the homeodomain abolished transactivation, while LIM B and truncation mutations retained residual activity. These mutations fail to act in a dominant-negative manner on wild-type LMX1B in mixing studies, thereby supporting haploinsufficiency as the mechanism underlying NPS pathogenesis.