Tacrolimus is macrolide drug that is widely used as a potent immunosuppressant. In the present work compatibility testing was conducted on physical mixtures of tacrolimus with excipients and on compatibility mixtures prepared by the simulation of manufacturing process used for the final drug product preparation. Increase in one major degradation product was detected in the presence of magnesium stearate based upon UHPLC analysis. The degradation product was isolated by preparative HPLC and its structure was elucidated by NMR and MS studies. Mechanism of the formation of this degradation product is proposed based on complementary degradation studies in a solution and structural elucidation data. The structure was proven to be alpha-hydroxy acid which is formed from the parent tacrolimus molecule through a benzilic acid type rearrangement reaction in the presence of divalent metallic cations. Degradation is facilitated at higher pH values.