The reaction pathways for 5'-hydroxylation and N-demethylation of nicotine catalyzed by cytochrome P450 were investigated by performing a series of first-principle electronic structure calculations on a catalytic reaction model system. The computational results indicate that 5'-hydroxylation of nicotine occurs through a two-state stepwise process, that is, an initial hydrogen atom transfer from nicotine to Cpd I (i.e., the HAT step) followed by a recombination of the nicotine moiety with the iron-bound hydroxyl group (i.e., the rebound step) on both the high-spin (HS) quartet and low-spin (LS) doublet states. The HAT step is the rate-determining one. This finding represents the first case that exhibits genuine rebound transition state species on both the HS and the LS states for C(alpha)-H hydroxylation of amines. N-Demethylation of nicotine involves a N-methylhydroxylation to form N-(hydroxymethyl)nornicotine, followed by N-(hydroxymethyl)nornicotine decomposition to nornicotine and formaldehyde. The N-methylhydroxylation step is similar to 5'-hydroxylation, namely, a rate-determining HAT step followed by a rebound step. The decomposition process occurs on the deprotonated state of N-(hydroxymethyl)nornicotine assisted by a water molecule, and the energy barrier is significantly lower than that of the N-methylhydroxylation process. Comparison of the rate-determining free energy barriers for the two reaction pathways predicts a preponderance of 5'-hydroxylation over the N-demethylation by roughly a factor of 18:1, which is in excellent agreement with the factor of 19:1 derived from available experimental data.