The extracellular matrix macromolecule laminin‐5 (Ln‐5) is converted by matrix metalloproteinases (MMP) MT1‐MMP and MMP‐2 into a migration‐promoting substrate in vitro. We now report that cleavage of Ln‐5 by MT1‐MMP occurs in vivo and affects epithelial tissue organization and probably Ln‐5 turnover. In MT1‐MMP knockout (KO) mice, the kidneys showed increased levels of total Ln‐5 γ2 subunit, but significantly reduced amounts of γ2′, an amino‐terminal truncated proteolytic form of γ2. The kidney tubular epithelia of KO animals were poorly differentiated, a phenotype reminiscent of human congenital mixed hypoplastic/dysplastic disorders. To establish a better link between Ln‐5 proteolytic cleavage and epithelial morphology, MT1‐MMP expression was reconstituted by transfection of MT1‐MMP into a Ln‐5 positive, MT1‐MMP deficient epithelial cell line. MT1‐MMP transfectants demonstrated increased levels of processed Ln‐5 γ2 chain and enhanced spreading on Ln‐5, but not fibronectin. Recombinant MT1‐MMP cleaved γ2 constructs in vitro at a known in vivo γ2 γ2’ processing site. These results strongly indicate that Ln‐5 is a physiological substrate of MT1‐MMP in vivo. Proteolytic processing of γ2 subunit by MT1‐MMP may influence Ln‐5 turnover in epithelial basement membranes and affect epithelial morphogenesis.