The Hedgehog (Hh) family of signaling molecules function as organizers in many morphogenetic processes. Hh signaling requires cholesterol in both signal-generating and -receiving cells, and it requires the tumor suppressor Patched (Ptc) in receiving cells in which it plays a negative role. Ptc both blocks the Hh pathway and limits the spread of Hh. Sequence analysis suggests that it has 12 transmembrane segments, 5 of which are homologous to a conserved region that has been identified in several proteins involved in cholesterol homeostasis and has been designated the sterol-sensing domain (SSD). In the present study, we show that a Ptc mutant with a single amino acid substitution in the SSD induces target gene activation in a ligand-independent manner. This mutant Ptc^SSD protein shows dominant-negative activity in blocking Hh signaling by preventing the downregulation of Smoothened (Smo), a positive effector of the Hh pathway. Despite its dominant-negative activity, the mutant Ptc protein functioned like the wild-type protein in sequestering and internalizing Hh. In addition, we show that Ptc^SSD preferentially accumulates in endosomes of the endocytic compartment. All these results suggest a role of the SSD of Ptc in mediating the vesicular trafficking of Ptc to regulate Smo activity.