This chapter reviews children's ability to distinguish imagination from reality. This distinction is in place by around age three, enabling children to separate real from imagined events and entities in pretend games and fictional stories. But children occasionally demonstrate imagination—reality confusions, as measured by their implicit reactions to certain kinds of pretend scenarios and their occasionally incorrect explicit reports about fictional entities. These confusions could be taken to show that children have an immature reality—imagination distinction. However, it is more accurate to conclude that this distinction is well developed but can be influenced by features of the task, such as the presence of strong negative emotions, and by individual difference variables, such as fantasy orientation.