Mammalian wounds typically heal by fibrotic repair without hair follicle (HF) regeneration. Fibrosis and regeneration are currently considered the opposite end of wound healing. This study sought to determine if scar could be remodeled to promote healing with HF regeneration. Here, we identify that activation of the Sonic hedgehog (Shh) pathway reinstalls a regenerative dermal niche, called dermal papilla, which is required and sufficient for HF neogenesis (HFN). Epidermal Shh overexpression or constitutive Smoothened dermal activation results in extensive HFN in wounds that otherwise end in scarring. While long-term Wnt activation is associated with fibrosis, Shh signal activation in Wnt active cells promotes the dermal papilla fate in scarring wounds. These studies demonstrate that mechanisms of scarring and regeneration are not distant from one another and that wound repair can be redirected to promote regeneration following injury by modifying a key dermal signal.