In the hallmark neuritic dystrophy of Alzheimer's disease (AD), autophagic vacuoles containing incompletely digested proteins selectively accumulate in focal axonal swellings, reflecting defects in both axonal transport and autophagy. Here, we investigated the possibility that impaired lysosomal proteolysis could be a basis for both of these defects leading to neuritic dystrophy. In living primary mouse cortical neurons expressing fluorescence-tagged markers, LC3-positive autophagosomes forming in axons rapidly acquired the endo-lysosomal markers Rab7 and LAMP1 and underwent exclusive retrograde movement. Proteolytic clearance of these transported autophagic vacuoles was initiated after fusion with bidirectionally moving lysosomes that increase in number at more proximal axon levels and in the perikaryon. Disrupting lysosomal proteolysis by either inhibiting cathepsins directly or by suppressing lysosomal acidification slowed the axonal transport of autolysosomes, late endosomes, and lysosomes and caused their selective accumulation within dystrophic axonal swellings. Mitochondria and other organelles lacking cathepsins moved normally under these conditions, indicating that the general functioning of the axonal transport system was preserved. Dystrophic swellings induced by lysosomal proteolysis inhibition resembled in composition those in several mouse models of AD and also acquired other AD-like features, including immunopositivity for ubiquitin, amyloid precursor protein, and hyperphosphorylated neurofilament proteins. Restoration of lysosomal proteolysis reversed the affected movements of proteolytic Rab7 vesicles, which in turn essentially cleared autophagic substrates and reversed the axonal dystrophy. These studies identify the AD-associated defects in neuronal lysosomal proteolysis as a possible basis for the selective transport abnormalities and highly characteristic pattern of neuritic dystrophy associated with AD.