We have developed an assay for a key step in the replication of adeno-associated virus (AAV) DNA. We demonstrate the covalently joined ends of linear AAV DNA can be resolved in vitro to the open duplex configuration. Only extracts prepared from human cells that have been infected with both adenovirus and AAV are capable of carrying out the reaction. The reaction is initiated by a site-specific and strand-specific endonucleolytic cut at a terminal resolution site near the end of the AAV terminal palindrome. During resolution the orientation of the terminal palindrome is inverted, and the 3' viral strand is extended by DNA synthesis. The size of the newly synthesized 3' strand is nearly identical to that found in viral particles. These observations provide direct biochemical evidence for an essential step in the model for AAV DNA replication.