TGF-β is an anti-inflammatory cytokine whose signaling is negatively controlled by Smad7. Previously, we established a role for Smad7 in the generation of autoreactive T cells; however, the function of Smad7 in dendritic cells (DCs) remains elusive. Here, we demonstrate that DC-specific Smad7 deficiency resulted in elevated expression of the transcription factors Batf3 and IRF8, leading to increased frequencies of CD8(+)CD103(+) DCs in the spleen. Furthermore, Smad7-deficient DCs expressed higher levels of indoleamine 2,3-dioxygenase (IDO), an enzyme associated with tolerance induction. Mice devoid of Smad7 specifically in DCs are resistant to the development of experimental autoimmune encephalomyelitis (EAE) as a result of an increase of protective regulatory T cells (Tregs) and reduction of encephalitogenic effector T cells in the central nervous system. In agreement, inhibition of IDO activity or depletion of Tregs restored disease susceptibility. Intriguingly, when Smad7-deficient DCs also lacked the IFN-γ receptor, the mice regained susceptibility to EAE, demonstrating that IFN-γ signaling in DCs mediates their tolerogenic function. Our data indicate that Smad7 expression governs splenic DC subset differentiation and is critical for the promotion of their efficient function in immunity.