Although genome-wide hypomethylation is a hallmark of many cancers, roles for active DNA demethylation during tumorigenesis are unknown. Here, loss of the APC tumor suppressor gene causes upregulation of a DNA demethylase system and the concomitant hypomethylation of key intestinal cell fating genes. Notably, this hypomethylation maintained zebrafish intestinal cells in an undifferentiated state that was released upon knockdown of demethylase components. Mechanistically, the demethylase genes are directly activated by Pou5f1 and Cebpβ and are indirectly repressed by retinoic acid, which antagonizes Pou5f1 and Cebpβ. Apc mutants lack retinoic acid as a result of the transcriptional repression of retinol dehydrogenase l1 via a complex that includes Lef1, Groucho2, Ctbp1, Lsd1, and Corest. Our findings imply a model wherein APC controls intestinal cell fating through a switch in DNA methylation dynamics. Wild-type APC and retinoic acid downregulate demethylase components, thereby promoting DNA methylation of key genes and helping progenitors commit to differentiation.