The endocytic delivery of macromolecules from the mammalian cell surface for degradation by lysosomal acid hydrolases requires traffic through early endosomes to late endosomes followed by transient (kissing) or complete fusions between late endosomes and lysosomes. Transient or complete fusion results in the formation of endolysosomes, which are hybrid organelles from which lysosomes are re-formed. We have used synthetic membrane-permeable cathepsin substrates, which liberate fluorescent reporters upon proteolytic cleavage, as well as acid phosphatase cytochemistry to identify which endocytic compartments are acid hydrolase active. We found that endolysosomes are the principal organelles in which acid hydrolase substrates are cleaved. Endolysosomes also accumulated acidotropic probes and could be distinguished from terminal storage lysosomes, which were acid hydrolase inactive and did not accumulate acidotropic probes. Using live-cell microscopy, we have demonstrated that fusion events, which form endolysosomes, precede the onset of acid hydrolase activity. By means of sucrose and invertase uptake experiments, we have also shown that acid-hydrolase-active endolysosomes and acid-hydrolase-inactive, terminal storage lysosomes exist in dynamic equilibrium. We conclude that the terminal endocytic compartment is composed of acid-hydrolase-active, acidic endolysosomes and acid hydrolase-inactive, non-acidic, terminal storage lysosomes, which are linked and function in a lysosome regeneration cycle.