Ubiquitylation is a highly controlled post-translational modification of proteins, in which proteins are conjugated either with monoubiquitin or polyubiquitin chains. Ubiquitin modifications on target proteins are recognized by ubiquitin-binding domains, which are found in several effector proteins. In this study, we describe for the first time how ubiquitin controls the function of the Toll-interacting protein (Tollip), which is an effector protein in the innate immune signaling pathway and an adaptor protein for endosomal trafficking. We have demonstrated that the central C2 domain of Tollip preferentially interacts with phosphoinositides with moderate affinity. Remarkably, we found that ubiquitin modulates Tollip's lipid binding. We have observed an ubiquitin dose-dependent inhibition of binding of Tollip to phosphoinositides and it does so specifically by blocking Tollip C2 domain-phosphoinositide interactions. This led us to discover that the Tollip C2 domain is a novel ubiquitin-binding domain. In addition, we have biophysically characterized the association of the Tollip CUE domain to ubiquitin and compared it with Tollip C2 domain-ubiquitin binding. The Tollip CUE domain reversibly binds ubiquitin with affinity higher than C2 domain and at a site that overlaps with that corresponding to the Tollip C2 domain. We have also found that ubiquitin binding to dimeric Tollip CUE domain induces a drastic conformational change in the protein, leading to the formation of a heterodimeric Tollip CUE-ubiquitin complex. These data suggest that ubiquitin binding to the Tollip C2 and CUE domains and ubiquitin-mediated dissociation of CUE dimer reduces the affinity of the Tollip protein for endosomal phosphoinositides, allowing Tollip's cytoplasmic sequestration. Overall, our findings will provide the structural and molecular basis to understand how Tollip works inside the cell and commit itself to cytosolic signalling or endosomal trafficking in a ligand dependent manner.