Bone marrow-derived allogeneic (donor derived) mesenchymal stem cells (MSCs) are immunoprivileged and are considered to be prominent candidates for regenerative therapy for numerous degenerative diseases. Even though the outcome of initial allogeneic MSCs based clinical trials was encouraging, the overall enthusiasm, of late, has dimmed down. This is due to failure of long-term survival of transplanted cells in the recipient. In fact, recent analyses of allogeneic MSC-based studies demonstrated that cells after transplantation turned immunogenic and were subsequently rejected by host immune system. The current study reveals a novel mechanism of immune switch in MSCs. We demonstrate that hypoxia, a common denominator of ischemic tissues, induces an immune shift in MSCs from immunoprivileged to immunogenic state. The immunoprivilege of MSCs is preserved by downregulation or the absence of major histocompatibility complex class II (MHC-II) molecules. We found that 26S proteasome-mediated intracellular degradation of MHC-II helps maintain the absence of MHC-II expression on cell surface in normoxic MSCs and preserves their immunoprivilege. The exposure to hypoxia leads to dissociation of 19S and 20S subunits, and inactivation of 26S proteasome. This prevented the degradation of MHC-II and, as a result, the MSCs became immunogenic. Furthermore, we found that hypoxia-induced decrease in the levels of a chaperon protein HSP90α is responsible for inactivation of 26S proteasome. Maintaining HSP90α levels in hypoxic MSCs preserved the immunoprivilege of MSCs. Therefore, hypoxia-induced inactivation of 26S proteasome assembly instigates loss of immunoprivilege of allogeneic mesenchymal stem cells. Maintaining 26S proteasome activity in mesenchymal stem cells preserves their immunoprivilege.