As musculoskeletal (MSK) disorders continue to increase globally, there is an increased need for novel, in vitro models to efficiently study human bone physiology in the context of both healthy and diseased conditions. For these models, the inclusion of innate immune cells is critical. Specifically, signaling factors generated from macrophages play key roles in the pathogenesis of many MSK processes and diseases, including fracture, osteoarthritis, infection etc. In this study, we aim to engineer three-dimensional (3D) and macrophage-encapsulated bone tissues in vitro, to model cell behavior, signaling, and other biological activities in vivo, in comparison to current two-dimensional models. We first investigated and optimized 3D culture conditions for macrophages, and then co-cultured macrophages with mesenchymal stem cells (MSCs), which were induced to undergo osteogenic differentiation to examine the effect of macrophage on new bone formation. Seeded within a 3D hydrogel scaffold fabricated from photocrosslinked methacrylated gelatin, macrophages maintained high viability and were polarized toward an M1 or M2 phenotype. In co-cultures of macrophages and human MSCs, MSCs displayed immunomodulatory activities by suppressing M1 and enhancing M2 macrophage phenotypes. Lastly, addition of macrophages, regardless of polarization state, increased MSC osteogenic differentiation, compared with MSCs alone, with proinflammatory M1 macrophages enhancing new bone formation most effectively. In summary, this study illustrates the important roles that macrophage signaling and inflammation play in bone tissue formation.