The role of the bone morphogenetic protein (BMP)‐signaling mediator Smad1 in osteogenic or chondrogenic differentiation was investigated in murine parental mesenchymal progenitors C3H10T½ and its derivatives constitutively expressing BMP‐2 (C3H10T½‐BMP‐2) and, therefore, undergo BMP‐mediated osteogenic/chondrogenic development. The functions of the three Smad1 domains, that is, the N‐terminal (MH1) domain, the C‐terminal (MH2) domain, and the midregional proline‐rich linker domain, were documented and compared with full‐length Smad1. We showed that expression of the MH2 domain in parental C3H10T½ cells was sufficient to initiate osteogenic differentiation. Interestingly, MH1 was sufficient to initiate transcription of osteogenic marker genes like the osteocalcin or parathyroid hormone/parathyroid hormone‐related protein (PTH/PTHrP) receptor. However, MH1 interfered with the histologically distinct formation of osteoblast‐like cells. A dominant‐negative effect on MH2‐mediated osteogenic development in C3H10T½ cells was observed by the dose‐dependent trans‐expression of the midregional linker domain. Importantly, in contrast to osteogenic differentiation, Smad1 and its domains do not mimic or interfere with BMP‐2‐dependent chondrogenic development as monitored by the inability of MH2 to give rise to histologically distinct chondrocytes in parental C3H10T½ cells and by the inefficiency of the MH1 or linker domain to interfere with BMP‐2‐mediated chondrogenic differentiation.