The proximal‐distal patterning of lung epithelium involves a complex series of signaling and transcriptional events resulting in the programmed differentiation of highly specialized cells for gas exchange and surfactant protein expression essential for postnatal lung function. The BMP signaling pathway has been shown to regulate cellular differentiation in the lung as well as other tissues. In this report, we show that the can family of related BMP antagonists, including gremlin, cer‐1, PRDC, and Dan are expressed in the lung during embryonic development with gremlin expression observed in the proximal airway epithelium. The role of gremlin in lung development was explored by overexpressing it in the distal lung epithelium of transgenic mice using the human SP‐C promoter. SP‐C/gremlin transgenic mice exhibited a disruption of the proximal‐distal patterning found in the airways of the mammalian lung. Expanded expression of the proximal epithelial cell markers CC10 and HFH‐4 (Foxj1) was observed in the distal regions of transgenic lungs. Furthermore, smooth muscle α‐actin expression was observed surrounding the distal airways of SP‐C/gremlin mice, indicating a proximalization of distal lung tubules. These data suggest that gremlin plays an important role in lung morphogenesis by regulating the proximal‐distal patterning of the lung during development. © 2001 Wiley‐Liss, Inc.