Cell surface heparan sulfate proteoglycans undergo unique intracellular degradation pathways after they are endocytosed from the cell surface. Heparanase, an endo-beta-glucuronidase capable of cleaving heparan sulfate, has been demonstrated to contribute to the physiological degradation of heparan sulfate proteoglycans and therefore regulation of their biological functions. A rat parathyroid cell line was found to produce heparanase with an optimal activity at neutral and slightly acidic conditions suggesting that the enzyme participates in heparan sulfate proteoglycan metabolism in extralysosomal compartments. To elucidate the detailed properties of the purified enzyme, the substrate specificity against naturally occurring heparan sulfates and chemically modified heparins was studied. Cleavage sites of rat heparanase were present in heparan sulfate chains obtained from a variety of animal organs, but their occurrence was infrequent (average, 1-2 sites per chain) requiring recognition of both undersulfated and sulfated regions of heparan sulfate. On the other hand intact and chemically modified heparins were not cleaved by heparanase. The carbohydrate structure of the newly generated reducing end region of heparan sulfate cleaved by the enzyme was determined, and it represented relatively undersulfated structures. O-Sulfation of heparan sulfate chains also played important roles in substrate recognition, implying that rat parathyroid heparanase acts near the boundary of highly sulfated and undersulfated domains of heparan sulfate proteoglycans. Further elucidation of the roles of heparanase in normal physiological processes would provide an important tool for analyzing the regulation of heparan sulfate-dependent cell functions.