Acid sphingomyelinase (aSMase) catalyzes the hydrolysis of sphingomyelin (SM) to form the bioactive lipid ceramide (Cer). Notably, aSMase exists in two forms: a zinc (Zn(2+))-independent lysosomal aSMase (L-SMase) and a Zn(2+)-dependent secreted aSMase (S-SMase) that arise from alternative trafficking of a single protein precursor. Despite extensive investigation into the maturation and trafficking of aSMase, the exact identity of mature L-SMase has remained unclear. Here, we describe a novel mechanism of aSMase maturation involving C-terminal proteolytic processing within, or in close proximity to, endolysosomes. Using two different C-terminal-tagged constructs of aSMase (V5, DsRed), we demonstrate that aSMase is processed from a 75-kDa, Zn(2+)-activated proenzyme to a mature 65 kDa, Zn(2+)-independent L-SMase. L-SMase is recognized by a polyclonal Ab to aSMase, but not by anti-V5 or anti-DsRed antibodies, suggesting that the C-terminal tag is lost during maturation. Furthermore, indirect immunofluorescence staining demonstrated that mature L-SMase colocalized with the lysosomal marker LAMP1, whereas V5-aSMase localized to the Golgi secretory pathway. Moreover, V5-aSMase possessed Zn(2+)-dependent activity suggesting it may represent the common protein precursor of S-SMase and L-SMase. Importantly, the 65-kDa L-SMase, but not V5-aSMase, was sensitive to the lysosomotropic inhibitor desipramine, co-fractionated with lysosomes, and migrated at the same M(r) as partially purified human aSMase. Finally, three aSMase mutants containing C-terminal Niemann-Pick mutations (R600H, R600P, ΔR608) exhibited defective proteolytic maturation. Taken together, these results demonstrate that mature L-SMase arises from C-terminal proteolytic processing of pro-aSMase and suggest that impaired C-terminal proteolysis may lead to severe defects in L-SMase function.