Morphogen signals are essential for cell fate specification during embryogenesis. Some receptors that sense these morphogen signals are known to localize to only the apical or basolateral membrane of polarized cell lines in vitro. How such localization affects morphogen sensing and patterning in the developing embryo remains unknown. Here, we show in the early mouse embryo that the formation of a robust BMP signaling gradient depends on restricted, basolateral localization of the BMP receptors. Mis-localizing these receptors to apical membrane leads to ectopic BMP signaling in the mouse embryo. To reach the basolaterally localized receptors in epiblast, BMP4 ligand, secreted by the extra-embryonic ectoderm, has to diffuses through the narrow interstitial space between the epiblast and the underlying endoderm. This restricted, basolateral diffusion creates a signaling gradient. The embryo geometry further buffers the gradient from fluctuations in the levels of BMP4. Our results demonstrate the importance of receptor localization and embryo geometry in shaping morphogen signaling during embryogenesis.