Cleavage of amyloid precursor protein (APP) by the Alzheimer's beta-secretase (BACE1) is a key step in generating amyloid beta-peptide, the main component of amyloid plaques. Here we report evidence that heparan sulfate (HS) interacts with beta-site APP-cleaving enzyme (BACE) 1 and regulates its cleavage of APP. We show that HS and heparin interact directly with BACE1 and inhibit in vitro processing of peptide and APP substrates. Inhibitory activity is dependent on saccharide size and specific structural characteristics, and the mechanism of action involves blocking access of substrate to the active site. In cellular assays, HS specifically inhibits BACE1 cleavage of APP but not alternative cleavage by alpha-secretase. Endogenous HS immunoprecipitates with BACE1 and colocalizes with BACE1 in the Golgi complex and at the cell surface, two of its putative sites of action. Furthermore, inhibition of cellular HS synthesis results in enhanced BACE1 activity. Our findings identify HS as a natural regulator of BACE1 and suggest a novel mechanism for control of APP processing.