Mutations of ephrin B1 in humans result in craniofrontonasal syndrome. Because little is known of the role and mechanism of action of ephrin B1 in bone, we examined the function of osteoblast-produced ephrin B1 in vivo and identified the molecular mechanism by which ephrin B1 reverse signaling regulates bone formation. Targeted deletion of the ephrin B1 gene in type 1alpha2 collagen-producing cells resulted in severe calvarial defects, decreased bone size, bone mineral density, and trabecular bone volume, caused by impairment in osterix expression and osteoblast differentiation. Coimmunoprecipitation of the TAZ complex with TAZ-specific antibody revealed a protein complex containing ephrin B1, PTPN13, NHERF1, and TAZ in bone marrow stromal (BMS) cells. Activation of ephrin B1 reverse signaling with soluble EphB2-Fc led to a time-dependent increase in TAZ dephosphorylation and shuttling from cytoplasm to nucleus. Treatment of BMS cells with exogenous EphB2-Fc resulted in a 4-fold increase in osterix expression as determined by Western blotting. Disruption of TAZ expression using specific lentivirus small hairpin RNA (shRNA) decreased TAZ mRNA by 80% and ephrin B1 reverse signaling-mediated increases in osterix mRNA by 75%. Knockdown of NHERF1 expression reduced basal levels of osterix expression by 90% and abolished ephrin B1-mediated induction of osterix expression. We conclude that locally produced ephrin B1 mediates its effects on osteoblast differentiation by a novel molecular mechanism in which activation of reverse signaling leads to dephosphorylation of TAZ and subsequent release of TAZ from the ephrin B1/NHERF1/TAZ complex to translocate to the nucleus to induce expression of the osterix gene and perhaps other osteoblast differentiation genes. Our findings provide strong evidence that ephrin B1 reverse signaling in osteoblasts is critical for BMS cell differentiation and bone formation.