ABSTRACT Expression of the budding yeast retrotransposon Ty3 results in production of viruslike particles (VLPs) and retrotransposition. The Ty3 major structural protein, Gag3, similar to retrovirus Gag, is processed into capsid, spacer, and nucleocapsid (NC) during VLP maturation. The 57-amino-acid Ty3 NC protein has 17 basic amino acids and contains one copy of the CX 2 CX 4 HX 4 C zinc-binding motif found in retrovirus NC proteins. Ty3 RNA, protein, and VLPs accumulate in clusters associated with RNA processing bodies (P bodies). This study investigated the role of the NC domain in Ty3-P body clustering and VLP assembly. Fifteen Ty3 NC Ala substitution and deletion mutants were examined using transposition, immunoblot, RNA protection, cDNA synthesis, and multimerization assays. Localization of Ty3 proteins and VLPs was characterized microscopically. Substitutions of each of the conserved residues of the zinc-binding motif resulted in the loss of Ty3 RNA packaging. Substitution of the first two of four conserved residues in this motif caused the loss of Ty3 RNA and protein clustering with P bodies and disrupted particle formation. NC was shown to be a mediator of formation of Ty3 RNA foci and association of Ty3 RNA and protein with P bodies. Mutations that disrupted these NC functions resulted in various degrees of Gag3 nuclear localization and a spectrum of different particle states. Our findings are consistent with the model that Ty3 assembly is associated with P-body components. We hypothesize that the NC domain acts as a molecular switch to control Gag3 conformational states that affect both assembly and localization.