The mechanism of the dirhodium tetracarboxylate-catalyzed O-H insertion reaction of diazomethane and methyl diazoacetate with H2O has been studied in detail using DFT calculations. The rhodium catalyst and a diazo compound couple to form a rhodiumcarbene complex. Of two reaction pathways of the Rh(II)-carbene complex with H2O, the stepwise pathway is more preferable than the concerted one. Formation of a Rh(II) complex-associated oxonium ylide is an exothermal process, and direct decomposition of the ylide gives a very high barrier. The high barriers for the 1,2-H shift of Rh(II) complex-associated oxonium ylides make the ylides become stable intermediates in both reactions, especially for the reactions in solution. Difficulty in formation of a free oxonium ylide supports experimental results, indicating that the Rh(II) complex-catalyzed nucleophilic addition of a diazo compound proceeds via a Rh(II) complex-associated oxonium ylide rather than via a free oxonium ylide.