Alzheimer's disease (AD) is caused by the cerebral deposition of beta-amyloid (Abeta), a 38-43-amino acid peptide derived by proteolytic cleavage of the amyloid precursor protein (APP). Initial studies indicated that final cleavage of APP by the gamma-secretase (a complex containing presenilin and nicastrin) to produce Abeta occurred in the endosomal/lysosomal system. However, other studies showing a predominant endoplasmic reticulum localization of the gamma-secretase proteins and a neutral pH optimum of in vitro gamma-secretase assays have challenged this conclusion. We have recently identified nicastrin as a major lysosomal membrane protein. In the present work, we use Western blotting and immunogold electron microscopy to demonstrate that significant amounts of mature nicastrin, presenilin-1, and APP are co-localized with lysosomal associated membrane protein-1 (cAMP-1) in the outer membranes of lysosomes. Furthermore, we demonstrate that these membranes contain an acidic gamma-secretase activity, which is immunoprecipitable with an antibody to nicastrin. These experiments establish APP, nicastrin, and presenilin-1 as resident lysosomal membrane proteins and indicate that gamma-secretase is a lysosomal protease. These data reassert the importance of the lysosomal/endosomal system in the generation of Abeta and suggest a role for lysosomes in the pathophysiology of AD.