Nine-year-old Hillary Lenox lives in a tidy house with attentive parents. Her backyard borders the overgrown, junk-strewn yard of the Connolly family. Sara-Kate Connolly, an eleven-year-old who has been held back a year in school, is known for her ill-fitting clothes, men's work boots, and fierce temperament. Sara-Kate's father no longer lives with the family, and her mother keeps the shades drawn and hardly ever goes outside. One afternoon, Sara-Kate invites Hillary into her backyard and shows her a miniature village: nine tiny houses made of sticks, string, and wire, with maple-leaf roofs and a small well fashioned from a bottlecap on a string. Sara-Kate insists elves built it. Hillary is skeptical, but the village captivates her. Mrs. Lenox discourages Hillary from playing in the Connollys' unsafe yard, but Hillary keeps returning.
At school, Hillary shares the discovery with her two closest friends, Jane Webster and Alison Mancini, who react with scorn. Sara-Kate refuses to let them visit, calling them "creeps." Jane and Alison warn Hillary that Sara-Kate stole a bicycle the previous spring and was caught by police. Shaken, Hillary distances herself for two days, but Sara-Kate lures her back by describing new additions to the village: a swimming pool and a Ferris wheel made from Popsicle sticks and two bicycle wheels. When Hillary returns, the Ferris wheel is more intricate than she imagined. She crouches to see the yard from an elf's perspective, and the junk-filled landscape appears enormous. Sara-Kate instructs her to always put herself in the position of the elf before speaking.
Over the following week, Hillary visits every afternoon. Sara-Kate shares extensive knowledge about elves: they have thick skins that keep them warm, they prefer to stay outside, they communicate in languages that sound like natural noises, and what is poisonous to humans is healthy for them. Everything Sara-Kate teaches inverts the values of Hillary's ordinary world: Elves prefer disorder, junk, and weeds to neatness. When Hillary interprets objects floating in the elves' pool as simple rafts, Sara-Kate challenges her, suggesting the leaves might collect starlight as energy and the wooden pieces might be power devices. She emphasizes that evidence can add up to different answers depending on how it is viewed. One afternoon, as Hillary prepares to leave, she glimpses a thin, frightening face staring down from an upstairs window before the shade snaps back.
Indian summer arrives, and the girls develop a genuine friendship while building roads and paths for the elves. Sara-Kate maintains strict boundaries: She refuses personal questions, never invites Hillary inside, and never offers her food. Hillary notices Sara-Kate secretly eating yard berries and chewing mint leaves. She also discovers that Sara-Kate handles adult responsibilities alone: picking up prescriptions, buying groceries, cashing checks, and restarting telephone service that has been shut off. At the telephone company, Sara-Kate explains to a questioning woman that her mother is sick, one of the few personal details Hillary learns.
In early November, Sara-Kate is absent from school for three days. Hillary enters the Connollys' house through the unlocked back door and finds the kitchen radically rearranged: furniture and appliances clustered in a circle, forming a room-within-a-room around the stove. The house is ice-cold. Hearing noises from the second floor, Hillary becomes convinced elves have moved indoors for winter and creeps upstairs. She opens a door streaming with light and finds not elves but Sara-Kate in a rocking chair, holding her thin, white-faced mother, whose feet drag on the floor. Sara-Kate attacks Hillary in a fury, shoving her out and threatening her never to return or tell anyone what she has seen.
Hillary tries to forget the scene. She returns to Jane and Alison but feels distracted and separate. She wrestles with what she witnessed, recalling Sara-Kate's lesson that evidence can be interpreted in multiple ways, and wonders if both the elves and Sara-Kate's reality as a caregiver could somehow be true at once. Then Hillary's father reveals he nearly hit Sara-Kate with his car late at night, proving she has not left town. Hillary realizes Sara-Kate and her mother are still in the house, hidden during the day. That night, she sneaks out and approaches the Connollys' yard. A small, coatless figure emerges: Sara-Kate. She lifts the fallen Ferris wheel back onto its cinder blocks, sweeps her hand through the air, and a sharp bird cry sounds overhead. The Ferris wheel begins to turn on its own, its spokes becoming a silvery tapestry, its seats flying out like golden rockets, before gradually slowing to a stop. Sara-Kate tells Hillary not to talk about it.
In bed that night, Hillary reasons through everything and becomes convinced Sara-Kate herself is an elf. Sara-Kate has thick skin, eats elf foods, hides within oversized clothes, and knows about elves from the inside. The next day, a snowstorm cancels school. The girls excavate the buried village, but Sara-Kate stiffens when she sees the upstairs shade raised: Her mother has been worse. She asks Hillary for money to buy groceries. Hillary takes $10 from her mother's wallet, lies about being invited for lunch, and walks to a store. When the total exceeds her money, she pockets a package of bologna. She delivers the groceries, and Sara-Kate invites her inside for the first time. They eat sandwiches together, warmed by the open stove. Sara-Kate reveals the furnace is broken and she keeps the electricity paid to prevent a shutoff. Hillary confronts Sara-Kate, saying she knows Sara-Kate does everything alone. Sara-Kate admits the truth, describing how she manages when her father's support checks do not arrive. She explains that if she asked for help, authorities would take her mother away. Regular people, she says, do not like people who are different or sick.
Hillary asks Sara-Kate directly if she is an elf. Sara-Kate's eyes open wide, and she appears ready to answer, but Mrs. Lenox's voice sounds from the yard. Mrs. Lenox enters the house and sees the dismantled kitchen. Sara-Kate invents explanations about workmen, but her thinness and shabby appearance alarm Mrs. Lenox, who insists on going upstairs. Sara-Kate does not resist. She sits on the bottom stair, and Hillary sits beside her; they are exactly the same size. Mrs. Lenox comes back down, hugs both girls, and says she is going to get help.
The once-silent house is flooded with activity as repairmen arrive and authorities intervene. A newspaper article describes Sara-Kate as keeping her mother prisoner, which Hillary angrily contradicts, insisting Sara-Kate was caring for her mother. Mrs. Lenox questions whether Hillary saw things clearly or only saw what Sara-Kate told her to see. Hillary is shaken by doubt but cannot resolve her conflicting feelings. Sara-Kate leaves on a plane with relatives without saying good-bye.
In the weeks that follow, Hillary tends the elf village daily. She reflects that everything Sara-Kate taught about elves turned out to be true about Sara-Kate herself: Being hungry, cold, angry, and alone does not preclude being an elf. When a new family is rumored to be buying the Connolly house, Hillary decides to move the village to the rocky, overgrown area behind her own garage, recognizing its disorder as precisely what an elf village needs. Her mother calls her inside from the darkening yard, but Hillary does not answer and seems to have disappeared, a final echo of the elves' invisibility and Sara-Kate's lesson that magic emerges when one looks deep enough.