Sir2 is an NAD-dependent histone deacetylase required for transcriptional silencing. To study the mechanism of Sir2 function, we examined the biochemical properties of purified recombinant Drosophila Sir2 (dSir2). First, we performed histone deacetylation assays and found that dSir2 deacetylates a broad range of acetylated lysine residues. We then carried out in vitro transcription experiments and observed that dSir2 does not repress transcription with either naked DNA templates or chromatin assembled from native (and mostly unacetylated) histones. It was possible, however, that repression by dSir2 requires an acetylated histone substrate. We therefore tested the transcriptional effects of dSir2 with native histones that were hyperacetylated by treatment with acetic anhydride. Assembly of the hyperacetylated histones onto DNA yields a soluble histone-DNA complex that differs from canonical nucleosomal chromatin. With this hyperacetylated histone-DNA complex, we observed potent (50- to 100-fold) NAD-dependent transcriptional repression by purified dSir2. In contrast, repression by dSir2 was not observed in parallel experiments in which histones were hyperpropionylated with propionic anhydride. We also found that dSir2 mediates the formation of a nuclease-resistant fast-sedimenting histone-DNA complex in an NAD-dependent manner. Unlike dSir2, the dHDAC1 deacetylase does not strongly repress transcription or generate a nuclease-resistant histone-DNA complex. Furthermore, with yeast Sir2, the transcriptional repression we observe correlates with deacetylation activity in vitro and silencing activity in vivo. These findings suggest that deacetylation by Sir2 causes a conformational change or rearrangement of histones into a transcriptionally repressive chromatin structure.