Terrell State Hospital was opened as a regional psychiatric hospital in July 1885. During the late nineteenth century, due to overcrowding in the state's only psychiatric treatment facility, located at Austin, eligible patients throughout Texas were often confined to county jails and poorhouses, both places incapable of treating the mentally ill. In 1881 state representative John S. Wood introduced a bill calling for the establishment of a branch of the Austin institution in North Texas. On February 16, 1883, the Eighteenth Texas Legislature passed Wood's bill, which specified that the new institution be located somewhere north of the tracks of the Texas and Pacific Railway. Terrell sent a committee to Austin to meet with the state officials involved in the selection process. The state location committee, acting upon information provided by the Terrell group, examined several locations in and around Terrell before selecting a 672.65-acre site a mile northeast of the town. Governor John Ireland commissioned the purchase of the tract, and the legislature appropriated $200,000 for the land and the construction of initial facilities. An additional 561 acres was leased to serve as pasture and cropland for the production of food for patients. The North Texas Lunatic Asylum, the purpose of which was the treatment and care of the "chronic incurable insane," opened on July 14, 1885, under a local board of managers. The hospital began operations with a five-man staff under Dr. David Richard Wallace, who had previously provided psychiatric treatment to Empress Carlota of Mexico. Only one-half of each wing of the facility's main building was complete upon opening. During its first year the institution admitted 330 patients from forty-six counties, and the following year it served 387 patients. This increase continued and necessitated an almost continual program of building and enlargement during the twentieth century.
In 1888 the hospital, reflecting contemporary changes in the understanding and treatment of mental illness, was renamed North Texas Hospital for the Insane. A new wing capable of housing 400 patients was completed in 1890. In 1906 the facility admitted 1,400 patients and employed a staff of 175. In response to the hospital's growth, it underwent "a virtual rebuilding" during the early twentieth century, and by 1920 housed 2,300 patients; it was thus the largest hospital of its kind west of the Mississippi River. In 1920 control of the hospital in Terrell passed from the local board of managers to the Board for Texas State Hospitals and Special Schools, which operated under the Board of Control. In 1925 the facility was renamed Terrell State Hospital. New wards were completed in 1937 and 1943, and laundry, power, and carpentry departments, as well as a paint shop, began operation during the same period. In 1945 2,663 patients were admitted. The hospital's population remained relatively steady between 1945 and the mid-1970s; its physical growth, however, continued. A 400-bed, air-conditioned ward was added in 1963. Oversight of the hospital was transferred to the Texas Department of Mental Health and Mental Retardation in September 1965. In 1967 the hospital treated 2,700 patients. From 1962 through 1978, $10 million was spent to improve the facility's physical plant. By 1970 the hospital, which served 2,568 patients, was organized into four geographic and three specialty units. Various occupational therapy programs, offered through workshops supported by industrial contracts that paid patients for certain jobs, had also been implemented. Outpatient programs were begun, and recreational facilities for Terrell State Hospital patients were constructed at nearby Lake Tawakoni; these increased in size and number in succeeding years. In 1993 the institution employed a staff of 1,294. The number of patients admitted to Terrell State Hospital declined in the decades after 1970, a reflection of the movement to reduce the number of patients institutionalized in psychiatric hospitals in the United States. The facility housed 1,652 patients in 1976, 715 in 1986, and 525 in 1988. In 1992 there were 2,899 admissions for the hospital's 521 beds. Despite declining numbers, however, the facility remained the single greatest asset to the economy of Terrell. In 1993 the hospital was administered by Dr. Girish V. Shah.