The promoter regions of approximately 40% of genes in the human genome are embedded in CpG islands, CpG-rich regions that frequently extend on the order of one kb 3' of the transcription start site (TSS) region. CpGs 3' of the TSS of actively transcribed CpG island promoters typically remain methylation-free, indicating that maintaining promoter-proximal CpGs in an unmethylated state may be important for efficient transcription. Here we utilize recombinase-mediated cassette exchange to introduce a Moloney Murine Leukemia Virus (MoMuLV)-based reporter, in vitro methylated 1 kb downstream of the TSS, into a defined genomic site. In a subset of clones, methylation spreads to within approximately 320 bp of the TSS, yielding a dramatic decrease in transcript level, even though the promoter/TSS region remains unmethylated. Chromatin immunoprecipitation analyses reveal that such promoter-proximal methylation results in loss of RNA polymerase II and TATA-box-binding protein (TBP) binding in the promoter region, suggesting that repression occurs at the level of transcription initiation. While DNA methylation-dependent trimethylation of H3 lysine (K)9 is confined to the intragenic methylated region, the promoter and downstream regions are hypo-acetylated on H3K9/K14. Furthermore, DNase I hypersensitivity and methylase-based single promoter analysis (M-SPA) experiments reveal that a nucleosome is positioned over the unmethylated TATA-box in these clones, indicating that dense DNA methylation downstream of the promoter region is sufficient to alter the chromatin structure of an unmethylated promoter. Based on these observations, we propose that a DNA methylation-free region extending several hundred bases downstream of the TSS may be a prerequisite for efficient transcription initiation. This model provides a biochemical explanation for the typical positioning of TSSs well upstream of the 3' end of the CpG islands in which they are embedded.