Macromolecular complexes containing presenilins (PS), nicastrin (NCT), APH-1, and PEN-2 mediate the gamma-secretase cleavage of the beta-amyloid precursor protein and Notch. APH-1 and NCT stabilize the PS1 holoprotein, whereas PEN-2 is critical for endoproteolysis of PS1. To define the structural domains of PEN-2 that are necessary for mediating PS1 endoproteolysis and gamma-secretase activity, we coexpressed APH-1, NCT, and PS1 together with a series of PEN-2 mutants, which harbored deletions in hydrophilic segments, or chimeric PEN-2 molecules that contained heterologous transmembrane domains (TMDs). We now report that with the exception of the PEN-2 variants with deletions proximal to the TMDs, the vast majority of the deletion variants were functional. Mutants that were nonfunctional were also unstable but were rescued by transposition of a heterologous sequence containing conservative amino acid substitutions into the deleted region. Notably, the carboxyl-terminal hydrophilic domain of PEN-2 was dispensable for promoting PS1 endoproteolysis but was critical for stabilizing the resulting PS1 derivatives. More importantly, we demonstrated that a chimeric PEN-2 with a replacement of the TMD2 with the TMD1 from sterol regulatory element binding protein 1 (SREBP-1) is fully functional but that a chimeric PEN-2 with a replacement of the TMD1 with the TMD2 from SREBP-1 is not. The function of this latter chimera was rescued by the replacement of the proximal two-thirds of the SREBP-1 TMD2 with the proximal two-thirds of the authentic TMD1 from PEN-2. These results suggest that the proximal two-thirds of the PEN-2 TMD1 is functionally important for endoproteolysis of PS1 holoproteins and the generation of PS1 fragments, essential components of the gamma-secretase complex.