A sterol-regulated protease initiates release of the NH2-terminal segments of sterol regulatory element-binding proteins (SREBPs) from cell membranes, thereby allowing them to enter the nucleus and to stimulate transcription of genes involved in the uptake and synthesis of cholesterol and fatty acids. Using SREBP-2 as a prototype, we here identify the site of sterol-regulated cleavage as the Leu522-Ser523 bond in the middle of the 31-residue hydrophilic loop that projects into the lumen of the endoplasmic reticulum and nuclear envelope. This site was identified through use of a vector encoding an SREBP-2/Ras fusion protein with a triple epitope tag that allowed immunoprecipitation of the cleaved COOH-terminal fragment. The NH2 terminus of this fragment was pinpointed by radiochemical sequencing after replacement of selected codons with methionine codons and labeling the cells with [35S]methionine. Alanine scanning mutagenesis revealed that only two amino acids are necessary for recognition by the sterol-regulated protease: 1) the leucine at the cleavage site (leucine 522), and 2) the arginine at the P4 position (arginine 519). These define a tetrapeptide sequence, RXXL, that is necessary for cleavage. Cleavage was not affected when the second transmembrane helix of SREBP-2 was replaced with the membrane-spanning region of the low density lipoprotein receptor, indicating that this sequence is not required for regulation. Glycosylation-site insertion experiments confirmed that leucine 522 is located in the lumen of the endoplasmic reticulum. We conclude that the sterol-regulated protease is a novel enzyme whose active site faces the lumen of the nuclear envelope, endoplasmic reticulum, or another membrane organelle to which the SREBPs may be transported before cleavage.