Endosomes along the degradation pathway leading to lysosomes accumulate membranes in their lumen and thus exhibit a characteristic multivesicular appearance. These lumenal membranes typically incorporate down-regulated EGF receptor destined for degradation, but the mechanisms that control their formation remain poorly characterized. Here, we describe a novel quantitative biochemical assay that reconstitutes the formation of lumenal vesicles within late endosomes in vitro. Vesicle budding into the endosome lumen was time-, temperature-, pH-, and energy-dependent and required cytosolic factors and endosome membrane components. Our light and electron microscopy analysis showed that the compartment supporting the budding process was accessible to endocytosed bulk tracers and EGF receptor. We also found that the EGF receptor became protected against trypsin in our assay, indicating that it was sorted into the intraendosomal vesicles that were formed in vitro. Our data show that the formation of intralumenal vesicles is ESCRT-dependent, because the process was inhibited by the K173Q dominant negative mutant of hVps4. Moreover, we find that the ESCRT-I subunit Tsg101 and its partner Alix control intralumenal vesicle formation, by acting as positive and negative regulators, respectively. We conclude that budding of the limiting membrane toward the late endosome lumen, which leads to the formation of intraendosomal vesicles, is controlled by the positive and negative functions of Tsg101 and Alix, respectively.