A mechanism of direct benzene hydroxylation over Fe-ZSM-5 zeolite is discussed from B3LYP density functional theory computations. We demonstrate using a mononuclear iron model supported at the AlO4- site of zeolite that Fe-ZSM-5 zeolite reasonably catalyzes the conversion of benzene to phenol with N2O. A key in this catalytic reaction is that benzene hydroxylation and N2O decomposition occur at the same active site in a well-balanced manner. In the initial stages of the reaction, a reactive oxygen species referred to as "alpha-oxygen" is formed upon decomposition of N2O at the iron active site. The first reaction step is the formation of a complex between benzene and the cc-oxygen species. The C-H activation of benzene leads to an intermediate that involves OH and C6H5 groups as ligands. After forming this intermediate, the reaction has a junction that leads to two possible pathways, depending on the concentration of N2O. The recombination between the OH and C6H5 ligands, which leads to a complex of phenol, can occur when the concentration of N2O is low, whereas the decomposition of nitrous oxide can occur on the intermediate involving OH and C6H5 groups when the N2O concentration is sufficiently high. Calculated potential energy diagrams and reaction kinetics show that the latter pathway is energetically more favorable than the former. We propose that benzene hydroxylation over Fe-ZSM-5 zeolite should proceed in the following way: (1) the formation of the benzene complex at the iron active site, (2) the hydrogen abstraction from benzene, (3) the decomposition of N2O at the active site, (4) the recombination between the OH and C6H5 ligands, and (5) the release of product phenol.