The 23-year-old army sergeant, surnamed Lim, had opened fire on other South Korean soldiers at a guard post on the eastern section of the heavily guarded frontier last night.
The shooting spree left five dead and seven wounded - and triggered a massive manhunt after Lee fled the scene armed with a K-2 assault rifle and a stash of ammunition.
A defence ministry spokesman said Lim had been tracked and cornered just before 2.30 pm local time at a location 10 kilometres from the border.
"The situation is still ongoing," he said.
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Kim So-Rae, a college student who lives in the area, said she had heard at least three separate exchanges of gunfire.
"There are helicopters flying overhead," Kim told YTN television by telephone.
"We have not been told anything yet, so we're not evacuating. It is pretty scary."
According to the military, Lim was due to be discharged in the next few months after completing his compulsory military service.
All those killed or wounded in yesterday's incident were members of Lim's own unit of the 22nd infantry division in the eastern province of Gangwon.
Special commandos and army helicopters were also brought in to speed up the operation, while local residents were warned to stay indoors.
Lim had difficulty adapting to the military, and past psychological evaluations had advised senior officers to pay him special attention, a defence ministry official who wished to remain anonymous told AFP.
This is not the first time the 22nd infantry has been involved in such an incident.
The soldier, Cho Jun-Hee, then crossed the border to defect to the North, a move which Pyongyang's state media later confirmed.