Rupture of endosomes and lysosomes is a major cellular stress condition leading to cell death and degeneration. Here, we identified an essential role for the ubiquitin‐directed AAA‐ATPase, p97, in the clearance of damaged lysosomes by autophagy. Upon damage, p97 translocates to lysosomes and there cooperates with a distinct set of cofactors including UBXD1, PLAA, and the deubiquitinating enzyme YOD1, which we term ELDR components for Endo‐Lysosomal Damage Response. Together, they act downstream of K63‐linked ubiquitination and p62 recruitment, and selectively remove K48‐linked ubiquitin conjugates from a subpopulation of damaged lysosomes to promote autophagosome formation. Lysosomal clearance is also compromised in MEFs harboring a p97 mutation that causes inclusion body myopathy and neurodegeneration, and damaged lysosomes accumulate in affected patient tissue carrying the mutation. Moreover, we show that p97 helps clear late endosomes/lysosomes ruptured by endocytosed tau fibrils. Thus, our data reveal an important mechanism of how p97 maintains lysosomal homeostasis, and implicate the pathway as a modulator of degenerative diseases.