The utility of grafting genetically modified cells to the mammalian brain was examined using the E. coli beta-galactosidase gene (lacZ) as a reporter gene in retroviral infection. Following implantation of the infected cells to the brain, lacZ continued to be expressed in vivo and could be detected easily with enzyme histochemistry. However, beta-galactosidase-positive cells were also observed in control grafts which had not been infected with the virus. This false-positive staining was found to be endogenous lysosomal activity associated with macrophage infiltration presumably induced by the damage associated with grafting. The E. coli gene product was distinguished from cellular lysosomal beta-galactosidase by using immunohistochemical staining with an antibody specific for E. coli beta-galactosidase. With this antibody, retrovirus-infected cells could be distinguished in the brain, and no false positives were observed in non-infected cells. We conclude that E. coli beta-galactosidase is a useful reporter gene for determining the fate of implanted cells to the brain if appropriate caution is taken to distinguish it from cellular beta-galactosidase by immunocytochemical procedures.