The Alzheimer's amyloid precursor (APP) is cleaved by an unidentified enzyme (APP secretase) to produce soluble APP. Fractionation of PC12 cell homogenates in a detergent-free buffer showed the presence of the Kunitz protease inhibitor (KPI)-containing soluble APP (nexin II) in the particulate fraction. Digitonin or sodium carbonate treatment of this fraction solubilized nexin II suggesting that it is contained in the lumen of vesicles. Nexin II production was not affected by lysosomotropic agents, suggesting that APP secretase is not a lysosomal enzyme. Labelling of cell surface proteins by iodination failed to detect full-length APP on the surface of PC12 cells, suggesting that most of this protein is located intracellularly. Furthermore, pulse-chase experiments showed that nexin II is detected in cell extracts before it appears in the culture medium. Cellular nexin II was detected at zero time of chase after only 5 min of pulse labelling with 35S-sulfate, indicated that APP secretase cleavage takes place immediately after APP is sulfated. Temperature block, pulse-chase, and 35S-sulfate-labelling experiments suggested that APP is cleaved by APP secretase intracellularly in the trans-Golgi network (TGN) or in a post-Golgi compartment.