diff --git a/railties/lib/rails/generators/rails/app/app_generator.rb b/railties/lib/rails/generators/rails/app/app_generator.rb
index ef5399e48f..22a27fdac2 100644
--- a/railties/lib/rails/generators/rails/app/app_generator.rb
+++ b/railties/lib/rails/generators/rails/app/app_generator.rb
@@ -3,6 +3,10 @@ require 'active_support/secure_random'
 require 'rails/version' unless defined?(Rails::VERSION)
 
 module Rails::Generators
+  # We need to store the RAILS_DEV_PATH in a constant, otherwise the path
+  # can change in Ruby 1.8.7 when we FileUtils.cd.
+  RAILS_DEV_PATH = File.expand_path("../../../../../..", File.dirname(__FILE__))
+
   class AppGenerator < Base
     DATABASES = %w( mysql oracle postgresql sqlite3 frontbase ibm_db )
     add_shebang_option!
@@ -15,17 +19,22 @@ module Rails::Generators
     class_option :template, :type => :string, :aliases => "-m",
                             :desc => "Path to an application template (can be a filesystem path or URL)."
 
+    class_option :dev, :type => :boolean, :default => false,
+                       :desc => "Setup the application with Gemfile pointing to your Rails checkout"
+
+    class_option :edge, :type => :boolean, :default => false,
+                        :desc => "Setup the application with Gemfile pointing to Rails repository"
+
     class_option :skip_activerecord, :type => :boolean, :aliases => "-O", :default => false,
-                                   :desc => "Skip ActiveRecord files"
+                                     :desc => "Skip ActiveRecord files"
 
     class_option :skip_testunit, :type => :boolean, :aliases => "-T", :default => false,
-                               :desc => "Skip TestUnit files"
+                                 :desc => "Skip TestUnit files"
 
     class_option :skip_prototype, :type => :boolean, :aliases => "-J", :default => false,
-                                :desc => "Skip Prototype files"
+                                  :desc => "Skip Prototype files"
 
-    # Add Rails options
-    #
+    # Add bin/rails options
     class_option :version, :type => :boolean, :aliases => "-v", :group => :rails,
                            :desc => "Show Rails version number and quit"
 
@@ -173,7 +182,6 @@ module Rails::Generators
       end
 
       # Define file as an alias to create_file for backwards compatibility.
-      #
       def file(*args, &block)
         create_file(*args, &block)
       end
@@ -190,6 +198,10 @@ module Rails::Generators
         ActiveSupport::SecureRandom.hex(64)
       end
 
+      def dev_or_edge?
+        options.dev? || options.edge?
+      end
+
       def self.banner
         "#{$0} #{self.arguments.map(&:usage).join(' ')} [options]"
       end
diff --git a/railties/lib/rails/generators/rails/app/templates/Gemfile b/railties/lib/rails/generators/rails/app/templates/Gemfile
index 8e851a64e7..59c6d333e2 100644
--- a/railties/lib/rails/generators/rails/app/templates/Gemfile
+++ b/railties/lib/rails/generators/rails/app/templates/Gemfile
@@ -1,9 +1,14 @@
 # Edit this Gemfile to bundle your application's dependencies.
-
+<% if !dev_or_edge? %>
 gem "rails", "<%= Rails::VERSION::STRING %>"
+<% end -%>
 
 ## Bundle edge rails:
-# gem "rails", :git => "git://github.com/rails/rails.git"
+<%- if options.dev? -%>
+gem "rails", :path => "<%= Rails::Generators::RAILS_DEV_PATH %>"
+<%- else -%>
+<%= "# " unless options.edge? %>gem "rails", :git => "git://github.com/rails/rails.git"
+<%- end -%>
 
 ## Bundle the gems you use:
 # gem "bj"
diff --git a/railties/test/generators/app_generator_test.rb b/railties/test/generators/app_generator_test.rb
index 10d0bc6bc2..567555fdc5 100644
--- a/railties/test/generators/app_generator_test.rb
+++ b/railties/test/generators/app_generator_test.rb
@@ -149,6 +149,19 @@ class AppGeneratorTest < GeneratorsTestCase
     assert_file 'lib/test_file.rb', 'heres test data'
   end
 
+  def test_dev_option
+    run_generator ["--dev"]
+    rails_path = File.expand_path('../../..', Rails.root)
+    dev_gem = %(gem "rails", :path => #{rails_path.inspect})
+    assert_file 'Gemfile', /^#{Regexp.escape(dev_gem)}$/
+  end
+
+  def test_edge_option
+    run_generator ["--edge"]
+    edge_gem = %(gem "rails", :git => "git://github.com/rails/rails.git")
+    assert_file 'Gemfile', /^#{Regexp.escape(edge_gem)}$/
+  end
+
   protected
 
     def run_generator(args=[])