A total of 40 fungal cultures were isolated for their ability to grow on caffeine as a sole source carbon and nitrogen, and further screened for theophylline-producing activities under the growing cell system. Based on thin-layer chromatography and high-performance liquid chromatography analyses, the potent strain Aureobasidium sp. TeO12 was chosen for its capability to generate theophylline via biotransformation of caffeine. It was identified based on phenotypic characteristics and its ITS1–5.8S–ITS2 rDNA sequencing data (GenBank accession number no. KT439072). To improve theophylline yield, the effects of various factors, such as resting cell density, Fe(II) concentration, and course of the transformation of caffeine, were studied in a biotransformation reaction containing 0.1 M sodium phosphate buffer (pH 7), Aureobasidium sp. TeO12 resting cells as the whole-cell catalyst and caffeine (2.5 g/L) as the substrate, and the reaction was incubated at 30 °C on an orbital shaker (200 rpm). The results indicated that optimal combination included resting cell density 6 g/L, Fe(II) concentration 75 mg/L, and the biotransformation time 72 h. Under these optimal reaction conditions, the highest theophylline concentration of 1.55 g/L (molar yield of 67%) with an average degradation yield of the substrate of about 83% was obtained in the biotransformation process. This is the first report on the biotransformation of caffeine into theophylline by a novel strain of the genus Aureobasidium.