The molecular mechanisms involved in transgene-induced gene silencing ('quelling') in Neurospora crassa were investigated using the carotenoid biosynthetic gene albino-1 (al-1) as a visual marker. Deletion derivatives of the al-1 gene showed that a transgene must contain at least approximately 132 bp of sequences homologous to the transcribed region of the native gene in order to induce quelling. Transgenes containing only al-1 promoter sequences do not cause quelling. Specific sequences are not required for gene silencing, as different regions of the al-1 gene produced quelling. A mutant defective in cytosine methylation (dim-2) exhibited normal frequencies and degrees of silencing, indicating that cytosine methylation is not responsible for quelling, despite the fact that methylation of transgene sequences frequently is correlated with silencing. Silencing was shown to be a dominant trait, operative in heterokaryotic strains containing a mixture of transgenic and non-transgenic nuclei. This result indicates that a diffusable, trans-acting molecule is involved in quelling. A transgene-derived, sense RNA was detected in quelled strains and was found to be absent in their revertants. These data are consistent with a model in which an RNA-DNA or RNA-RNA interaction is involved in transgene-induced gene silencing in Neurospora.