Inositol lipids play key roles in many fundamental cellular processes that include growth, cell survival, motility, and membrane trafficking. Recent studies on the PTEN and Myotubularin proteins have underscored the importance of inositol lipid 3-phosphatases in cell function. Inactivating mutations in the genes encoding PTEN and Myotubularin are key steps in the progression of some cancers and in the onset of X-linked myotubular myopathy, respectively. Myotubularin-related protein 3 (MTMR3) shows extensive homology to Myotubularin, including the catalytic domain, but additionally possesses a C-terminal extension that includes a FYVE domain. We show that MTMR3 is an inositol lipid 3-phosphatase, with a so-far-unique substrate specificity. It is able to hydrolyze PtdIns3P and PtdIns3,5P2, both in vitro and when heterologously expressed in S. cerevisiae, and to thereby provide the first clearly defined route for the cellular production of PtdIns5P. Overexpression of a catalytically dead MTMR3 (C413S) in mammalian cells induces a striking formation of vacuolar compartments that enclose membranous structures that are highly concentrated in mutant proteins.