diff --git a/cache.h b/cache.h
index 81b7e17de2..56ac6e7f47 100644
--- a/cache.h
+++ b/cache.h
@@ -525,6 +525,7 @@ static inline int is_absolute_path(const char *path)
 }
 const char *make_absolute_path(const char *path);
 const char *make_nonrelative_path(const char *path);
+const char *make_relative_path(const char *abs, const char *base);
 
 /* Read and unpack a sha1 file into memory, write memory to a sha1 file */
 extern int sha1_object_info(const unsigned char *, unsigned long *);
diff --git a/path.c b/path.c
index 7a35a26a16..6e3df18499 100644
--- a/path.c
+++ b/path.c
@@ -330,6 +330,23 @@ const char *make_nonrelative_path(const char *path)
 /* We allow "recursive" symbolic links. Only within reason, though. */
 #define MAXDEPTH 5
 
+const char *make_relative_path(const char *abs, const char *base)
+{
+	static char buf[PATH_MAX + 1];
+	int baselen;
+	if (!base)
+		return abs;
+	baselen = strlen(base);
+	if (prefixcmp(abs, base))
+		return abs;
+	if (abs[baselen] == '/')
+		baselen++;
+	else if (base[baselen - 1] != '/')
+		return abs;
+	strcpy(buf, abs + baselen);
+	return buf;
+}
+
 const char *make_absolute_path(const char *path)
 {
 	static char bufs[2][PATH_MAX + 1], *buf = bufs[0], *next_buf = bufs[1];
diff --git a/setup.c b/setup.c
index d630e374e7..3b111ea7cf 100644
--- a/setup.c
+++ b/setup.c
@@ -292,9 +292,10 @@ void setup_work_tree(void)
 	work_tree = get_git_work_tree();
 	git_dir = get_git_dir();
 	if (!is_absolute_path(git_dir))
-		set_git_dir(make_absolute_path(git_dir));
+		git_dir = make_absolute_path(git_dir);
 	if (!work_tree || chdir(work_tree))
 		die("This operation must be run in a work tree");
+	set_git_dir(make_relative_path(git_dir, work_tree));
 	initialized = 1;
 }