Cumulative evidence supports an important role for RPTPσ in the development of the nervous system and nerve regeneration. However, the signaling mechanisms regulated by RPTPσ remain largely unknown and the identification of RPTPσ substrate(s) and binding partners is essential to understanding its mechanisms of action. We employed a modified yeast-two-hybrid approach, the yeast substrate-trapping system, to identify new substrates and interacting partners of RPTPσ. The binding proteins RPTPδ, Liprinα4, p130Cas and Trio were found to interact with RPTPσ in the yeast system independently of tyrosine phosphorylation. Importantly, using the trapping mutant of RPTPσ we identified p250GAP as a novel substrate and RPTPσ displayed its phosphatase specificity toward p250GAP in vitro. In the mammalian expression system, the trapping mutant of RPTPσ recognized p250GAP as its physiological substrate in the presence of active Fyn, suggesting that the interaction of the two proteins is primarily dependent on tyrosine phosphorylation. Furthermore, p250GAP activity increased in the presence of RPTPσ leading to attenuated Rac activity. Overexpression of p250GAP and RPTPσ inhibited axonal outgrowth in differentiated PC12 cells. Cumulative evidence implicates that RPTPσ modulates the actin cytoskeleton by regulating Rac GTPase activity through p250GAP. Taken together, our results demonstrate for the first time that RPTPσ modulates Rac dependent activity through regulating a novel substrate, p250GAP.