beta-Secretase (BACE, Asp-2) is a transmembrane aspartic proteinase responsible for cleaving the amyloid precursor protein (APP) to generate the soluble ectodomain sAPPbeta and its C-terminal fragment CTFbeta. CTFbeta is subsequently cleaved by gamma-secretase to produce the neurotoxic/synaptotoxic amyloid-beta peptide (Abeta) that accumulates in Alzheimer's disease. Indirect evidence has suggested that amyloidogenic APP processing may preferentially occur in lipid rafts. Here, we show that relatively little wild-type BACE is found in rafts prepared from a human neuroblastoma cell line (SH-SY5Y) by using Triton X-100 as detergent. To investigate further the significance of lipid rafts in APP processing, a glycosylphosphatidylinositol (GPI) anchor has been added to BACE, replacing the transmembrane and C-terminal domains. The GPI anchor targets the enzyme exclusively to lipid raft domains. Expression of GPIBACE substantially up-regulates the secretion of both sAPPbeta and amyloid-beta peptide over levels observed from cells overexpressing wild-type BACE. This effect was reversed when the lipid rafts were disrupted by depleting cellular cholesterol levels. These results suggest that processing of APP to the amyloid-beta peptide occurs predominantly in lipid rafts and that BACE is the rate-limiting enzyme in this process. The processing of the APP695 isoform by GPI-BACE was up-regulated 20-fold compared with wild-type BACE, whereas only a 2-fold increase in the processing of APP751/770 was seen, implying a differential compartmentation of the APP isoforms. Changes in the local membrane environment during aging may facilitate the cosegregation of APP and BACE leading to increased beta-amyloid production.