The requirement of Y-chromosome activity for the differentiation of somatic cells and germ cells was studied in the fetal gonads of X/XSxra mouse embryos where the activity of the Sxra fragment of the Y chromosome is influenced by the inactivation and reactivation of the X chromosome. In the interstitial somatic cells, random inactivation of the X and the XSxra chromosomes took place which was revealed by the mosaic expression of an X-linked lacZ transgene. The Sertoli cells, however, displayed a preferentially active XSxra chromosome and the presence of Sxra-active Sertoli cells was associated with the morphogenesis of testicular tubules in the sex-reversed gonads. The activity of the Y-chromosome fragment is therefore necessary for the differentiation of the Sertoli cells which may direct the development of the testis. The expression pattern of the X-linked transgene in X/XSxra germ cells suggests that both the X and the XSxra chromosomes are active. This finding suggests that the presence of Sxra has no impact on the reactivation of the X chromosome in the germ cells and that the X chromosome can be reactivated even though the germ cells are found in the testicular environment. Our results are consistent with the concept that the activity of genes on the XSxra fragment is essential for the differentiation of Sertoli cells and the morphogenesis of the testis, but not for premeiotic differentiation of germ cells in sex-reversed mice.