As a boy living in an Irish neighborhood of Southie, Boston, Colin Sullivan (Matt Damon) is introduced to organized crime through Irish mob boss Frank Costello (Jack Nicholson). Costello grooms him to become his mole inside the Massachusetts State Police where Sullivan is accepted into the Special Investigations Unit (SIU). Concurrently, Billy Costigan (Leonardo DiCaprio), prior to graduating from the police academy, is recruited by Captain Oliver Queenan (Martin Sheen) and Staff Sergeant Sean Dignam (Mark Wahlberg) to become an undercover agent to infiltrate Costello's gang. Costigan agrees, requiring him to drop out of the academy and do time in prison on a fake assault charge to increase his street credibility.
Sullivan begins a romance with psychiatrist Dr. Madolyn Madden (Vera Farmiga) who Costigan, coincidentally, sees for his probation. Costigan also develops an intimate relationship with Madolyn, making love to her the night before she moves in with Sullivan. After barely escaping a sting operation, Costello suspects a confidential informant within his organization, resulting in both Costigan and Sullivan becoming aware of each other as counterparts, though not knowing the other's identity. Costello collects the social security numbers of his gang for Sullivan to use police resources to do background checks. He meets Sullivan at an adult movie theatre and gives him the information as Costigan surveils. Costigan then chases Sullivan through Boston's Chinatown to arrest him, but Sullivan evades capture, stabbing an innocent bystander in the process.
Determined to find the informant, Sullivan has Queenan tailed by a unit of troopers when he meets with Costigan in an abandoned building. Costello's mobsters arrive as well, and enter the building and Queenan stalls them to allow Costigan time to escape. Queenan is thrown from the roof for his efforts, landing dead right in front of Costigan as he exits the building. When the mobsters happen upon Costigan as they flee the scene, he pretends he came late to join them on the hit. The trailing state troopers open fire on the mobsters and the ensuing shootout results in casualties on both sides. Later, at one of Costello's safe houses, enforcer Timothy Delahunt (Mark Rolston), who was mortally wounded in the shootout, privately tells Costigan he gave him the wrong address yet Costigan managed to show up late at the correct place. Costigan becomes alarmed at the insinuation, but Delahunt dies before revealing the information to anyone else. When Costello's other enforcer Fitzgibbons (David O'Hara), is unsuccessful in properly hiding Delahunt's corpse, it's revealed that Delahunt was an undercover cop with the Boston Police Department. Costello remains unconvinced, however, suspecting the police are attempting to lull him into dropping his effort to find the true informant.
Now under intense scrutiny, Sullivan is attacked by a suspicious Dignam because of Queenan's death. SIU Commander Captain George Ellerby (Alec Baldwin) places Dignam on leave. Using Queenan's phone, Sullivan reaches Costigan who refuses to abort his mission. Sullivan then learns from Queenan's diary that Costello is an informant for the F.B.I., causing him to worry about his dual identity being revealed. With Costigan's help, Costello is tracked to a cocaine deal, where he and his gang become trapped in a gunfight with police, resulting in most of the mobsters being killed. Confronted by Sullivan with the evidence, Costello admits to being an FBI informant as a means of protecting himself and his illegal business activities. Sullivan then kills Costello and is later commended by the entire department for his actions. With Costello dead, Costigan comes in on good faith, requesting Sullivan restore his true identity. Sullivan agrees and leaves to get the proper documentation, during which time Costigan notices the envelope containing the mobster's social security numbers. He surmises that Sullivan is the mole and flees. Upon returning to his office and concluding he's been found out, Sullivan erases all records of Costigan from the police computer database.
Costigan leaves an envelope with evidence in the care of Madolyn for safekeeping, advising he'll meet with her in two weeks to pick it up. Later, she divulges her pregnancy to Sullivan, but doesn't say who the father is. Madolyn then finds a package with the mail, sent from Costigan with a CD and a phone number for Sullivan. She listens and discovers the CD is recordings of conversations. Sullivan walks in on her and tries to assuage her suspicions, but she locks herself away from him. He hastily contacts Costigan, who informs him Costello recorded every conversation he had with Sullivan, plotting to use them for an immunity deal if he were to be apprehended. Since Costigan was the only person Costello actually trusted, Costello's attorney left Costigan in possession of the recordings and therefore Costigan intends to implicate Sullivan. They agree to meet on the roof of the building where Queenan died.
At the meet, Costigan ambushes Sullivan and assaults and hand-cuffs him at gunpoint. As Costigan had secretly arranged, Trooper Brown (Anthony Anderson) shows up and, upon finding Sullivan in hand-cuffs, draws his gun on Costigan. Costigan attempts to justify his actions by exposing Sullivan as the mole but Brown is skeptical. Using Sullivan as a shield, Costigan leaves with him in the elevator. When he arrives on the ground floor, Costigan is shot point blank in the head by Trooper Barrigan (James Badge Dale). Barrigan then shoots Brown as well and reveals to Sullivan that Costello had more than one mole in the department and suggests they work together to avoid being traded to the FBI. Sullivan waits for Barrigan to turn away then shoots him in the back of the head. Later, during his debriefing, Sullivan blames all mole activity on Barrigan and has Costigan posthumously given the Medal of Merit.
At Costigan's funeral, Sullivan attempts to speak with a distraught Madolyn about the future of her child, but she ignores him. Some time later, Sullivan comes home from grocery shopping and is executed by Dignam, who became aware of his treachery. Dignam, wearing hospital booties and surgical gloves to avoid leaving traces of his presence, calmly exits Sullivan's apartment as a rat crawls along the balcony with the view of the Massachusetts State House in the background.
