Transglutaminase 2 (TG2) catalyzes cross-linking or deamidation of glutamine residues in peptides and proteins. The in vivo deamidation of gliadin peptides plays an important role in the immunopathogenesis of celiac disease (CD). Although deamidation is considered to be a side-reaction occurring in the absence of suitable amines or at a low pH, a recent paper reported the selective deamidation of the small heat shock protein 20 (Hsp20), suggesting that deamidation could be a substrate dependent event. Here we have measured peptide deamidation and transamidation in the same reaction to reveal factors that affect the relative propensity for the two possible products. We report that the propensity for deamidation by TG2 is both substrate dependent and influenced by the reaction conditions. Direct deamidation is favored for poor substrates and at low concentrations of active TG2, while indirect deamidation (i.e. hydrolysis of transamidated product) can significantly contribute to the deamidation of good peptide substrates at higher enzyme concentrations. Further, we report for the first time that TG2 can hydrolyze iso-peptide bonds between two peptide substrates. This was observed also for gliadin peptides introducing a novel route for the generation of deamidated T cell epitopes in celiac disease.