Palmitoylation is a key post-translational modification mediated by a family of DHHC-containing palmitoyl acyl-transferases (PATs). Unlike other lipid modifications, palmitoylation is reversible and thus often regulates dynamic protein interactions. We find that the mouse hair loss mutant, depilated, (dep) is due to a single amino acid deletion in the PAT, Zdhhc21, resulting in protein mislocalization and loss of palmitoylation activity. We examined expression of Zdhhc21 protein in skin and find it restricted to specific hair lineages. Loss of Zdhhc21 function results in delayed hair shaft differentiation, at the site of expression of the gene, but also leads to hyperplasia of the interfollicular epidermis (IFE) and sebaceous glands, distant from the expression site. The specific delay in follicle differentiation is associated with attenuated anagen propagation and is reflected by decreased levels of Lef1, nuclear beta-catenin, and Foxn1 in hair shaft progenitors. In the thickened basal compartment of mutant IFE, phospho-ERK and cell proliferation are increased, suggesting increased signaling through EGFR or integrin-related receptors, with a parallel reduction in expression of the key differentiation factor Gata3. We show that the Src-family kinase, Fyn, involved in keratinocyte differentiation, is a direct palmitoylation target of Zdhhc21 and is mislocalized in mutant follicles. This study is the first to demonstrate a key role for palmitoylation in regulating developmental signals in mammalian tissue homeostasis.