The proper functioning of the placenta requires specific patterns of methylation and the appropriate regulation of retroelements, some of which have been co-opted by the genome for placental-specific gene expression. Our inquiry was initiated to determine the causes of the placental defects observed in crosses between two species of mouse, Mus musculus and Mus caroli. M. musculus × M. caroli fetuses are rarely carried to term, possibly as a result of genomic incompatibility in the placenta. Taking into account that placental dysplasia is observed in Peromyscus and other Mus hybrids, and that endogenous retroviruses are expressed in the placental transcriptome, we hypothesized that these placental defects could result, in part, from failure of the genome defense mechanism, DNA methylation, to regulate the expression of retroelements. Hybrid M. musculus × M. caroli embryos were produced by artificial insemination, and dysplastic placentas were subjected to microarray and methylation screens. Aberrant overexpression of an X-linked Mus retroelement in these hybrid placentas is consistent with local demethylation of this retroelement, concomitant with genome instability, disruption of gene regulatory pathways, and dysgenesis. We propose that the placenta is a specific site of control that is disrupted by demethylation and retroelement activation in interspecific hybridization that occur as a result of species incompatibility of methylation machinery. To our knowledge, the present data provide the first report of retroelement activation linked to decreased methylation in a eutherian hybrid system.