Nicastrin is a component of the Notch signaling pathway involved in proteolytic release of the Notch receptor intracellular domain. It has been postulated that intracellular Notch is required within the nucleus of fly eye progenitor cells to enhance (pro-neural enhancement) and then repress (lateral inhibition) transcription of pro-neural genes. We present here an analysis of Nicastrin function during eye development and find that Nicastrin is essential to early photoreceptor neuron development. Nicastrin mutant tissue displays neuronal loss or hyperplasia; these phenotypes can be rescued by targeted expression of an intracellular form of Notch. Thus, nuclear translocation of Notch and its direct regulation of gene expression appear to be critical to pro-neural enhancement as well as lateral inhibition. In addition, we show that Nicastrin as well as Notch are required to maintain normal R-cell morphology, because the nuclei of mutant photoreceptor neurons cannot maintain their proper position. Thus, Notch signaling plays a role, not only in cell fate specification, but also in differentiation of photoreceptor neurons.