Peroxisome proliferator-activated receptor gamma (PPARG) is a master transcriptional regulator of adipocyte differentiation and a canonical target of antidiabetic thiazolidinedione medications. In rare families, loss-of-function (LOF) mutations in PPARG are known to cosegregate with lipodystrophy and insulin resistance; in the general population, the common P12A variant is associated with a decreased risk of type 2 diabetes (T2D). Whether and how rare variants in PPARG and defects in adipocyte differentiation influence risk of T2D in the general population remains undetermined. By sequencing PPARG in 19,752 T2D cases and controls drawn from multiple studies and ethnic groups, we identified 49 previously unidentified, nonsynonymous PPARG variants (MAF < 0.5%). Considered in aggregate (with or without computational prediction of functional consequence), these rare variants showed no association with T2D (OR = 1.35; P = 0.17). The function of the 49 variants was experimentally tested in a novel high-throughput human adipocyte differentiation assay, and nine were found to have reduced activity in the assay. Carrying any of these nine LOF variants was associated with a substantial increase in risk of T2D (OR = 7.22; P = 0.005). The combination of large-scale DNA sequencing and functional testing in the laboratory reveals that approximately 1 in 1,000 individuals carries a variant in PPARG that reduces function in a human adipocyte differentiation assay and is associated with a substantial risk of T2D.