Deletions and chromosome re-arrangements are common features of cancer cells. We have established a new two-component system reporting on epigenetic silencing or deletion of an actively transcribed gene adjacent to a double-strand break (DSB). Unexpectedly, we find that a targeted DSB results in a minority (<10%) misrepair event of kilobase deletions encompassing the DSB site and transcribed gene. Deletions are reduced upon RNaseH1 over-expression and increased after knockdown of the DNA:RNA helicase Senataxin, implicating a role for DNA:RNA hybrids. We further demonstrate that the majority of these large deletions are dependent on the 3' flap endonuclease XPF. DNA:RNA hybrids were detected by DNA:RNA immunoprecipitation in our system after DSB generation. These hybrids were reduced by RNaseH1 over-expression and increased by Senataxin knock-down, consistent with a role in deletions. Overall, these data are consistent with DNA:RNA hybrid generation at the site of a DSB, mis-processing of which results in genome instability in the form of large deletions.