Lactose is usually broken down into glucose and galactose. This is done in a specific part of the small intestine called the duodenum. The duodenum is covered with hair like structures that increase the suface area through which absorbtion can take place. The lactase enzyme present in this "brush border" is respoponsible for the breakdown of lactose can can reduce significantly after infancy.
"Lactose, a disaccharide, is present in milk and processed foods. Dietary lactose must be hydrolyzed to a monosaccharide in order to be absorbed by the small intestinal mucosa. A deficiency of intestinal lactase prevents hydrolysis of ingested lactose. The osmotic load of the unabsorbed lactose causes secretion of fluid and electrolytes until osmotic equilibrium is reached. Dilation of the intestine caused by the osmosis induces an acceleration of small intestinal transit, which increases the degree of maldigestion. Within the large intestine, free lactose is fermented by colonic bacteria to yield short-chain fatty acids and hydrogen gas. The combined increase in fecal water, intestinal transit, and generated hydrogen gas accounts for the wide range of gastrointestinal symptoms." (Mediscape - http://emedicine.medscape.com/article/187249-overview#a0104)
1.Vesa TH, Marteau P, Korpela R. Lactose intolerance. J Am Coll Nutr. Apr 2000;19(2 Suppl):165S-175S. [Medline].