Wallace was born in Brookville, Indiana, to David Wallace and Esther French Test Wallace. His father was a graduate of the United States Military Academy and served as lieutenant governor and Indiana Governor; his stepmother, Zerelda Gray Sanders Wallace, was a prominent suffragist and temperance advocate. When Wallace's father was elected as lieutenant governor of Indiana, he moved his family to Covington, Indiana. Wallace's autobiography contains many descriptive stories of this boyhood in Covington, including the account of the death of his mother in 1834. In 1836, at the age of nine, he joined his brother in Crawfordsville, Indiana, where he briefly attended Wabash Preparatory School. Afterward he joined his father in Indianapolis.

Wallace was studying law at the start of the Mexican-American War in 1846. He raised a company of militia and was elected a second lieutenant in the 1st Indiana Infantry regiment. He rose to the position of regimental adjutant and the rank of first lieutenant, serving in the army of Zachary Taylor, although he personally did not participate in combat. After hostilities he was mustered out of the volunteer service on June 15, 1847. He was admitted to the bar in 1849. In 1851 he was elected prosecuting attorney of the First Congressional District.

On May 6, 1852, Wallace married Susan Arnold Elston by whom he had one son, Henry Lane Wallace (born February 17, 1853). In 1856, he was elected to the State Senate after moving his residence to Crawfordsville.

At the start of the American Civil War, Wallace was appointed state adjutant general and helped raise troops in Indiana. On April 25, 1861, he was appointed Colonel of the 11th Indiana Infantry. After brief service in western Virginia, he was promoted to brigadier general of volunteers on September 3 and given the command of a brigade.

Forts Henry & Donelson

In February 1862, while preparing for an advance against Fort Henry, Brig. Gen. Ulysses S. Grant sent two wooden gunboats (timberclads) down the Tennessee River for one last reconnaissance of the fort with Wallace aboard. In his report, Wallace noted an officer in the fort who was watching the Union ships as inquisitively as they were watching him. Little did Wallace know at that time the officer was Brig. Gen. Lloyd Tilghman, whom Wallace would replace as commander of Fort Henry in a few days. During the campaign Wallace's brigade was attached to Brig. Gen. Charles F. Smith's division and occupied Fort Heiman across the river from Fort Henry. Grant's superior, Maj. Gen. Henry W. Halleck, was concerned about Confederate reinforcements retaking the forts so Grant left Wallace with his brigade in command at Fort Henry while the rest of the army moved overland toward Fort Donelson.Wallace was displeased to have been left behind so he had his troops ready to move out at a moment's notice. The order came on February 14, and when Wallace arrived along the Cumberland River, he was placed in charge of organizing a division of reinforcements arriving on transports. He was able to organize two full brigades and a third incomplete, and took up position in the center of Grant's lines besieging Fort Donelson. During the fierce Confederate assault on February 15, Wallace coolly acted on his own initiative to send a brigade to reinforce the beleaguered division of Brig. Gen. John A. McClernand, despite orders from Grant to avoid a general engagement. This action was key in stabilizing the Union defensive line. After this Confederate assault had been checked, Wallace led a counter attack which retook the ground that was lost. Wallace was promoted to major general to rank from March 21.

Shiloh

Wallace's most controversial command came at the Battle of Shiloh, where he continued as a division commander under Grant. Wallace's division had been left as reserves at a place called Stoney Lonesome to the rear of the Union line. At about 6 a.m., when Grant's army was surprised and virtually routed by the sudden appearance of the Confederate States Army under Albert Sidney Johnston, Grant sent orders for Wallace to move his unit up to support the division of William Tecumseh Sherman.

Here, the controversy begins. Wallace claimed that Grant's orders were unsigned, hastily written, and overly vague. There were two paths by which Wallace could move his unit to the front, and Grant (according to Wallace) did not specify which one he should take. Wallace chose to take the upper path, which was much less used and in considerably better condition, and which would lead him to the right side of Sherman's last known position. Grant later claimed that he had specified that Wallace take the lower path, though circumstantial evidence suggests that Grant had forgotten that more than one path even existed.

Whatever the case, Wallace arrived at the end of his march only to find that Sherman had been forced back, and was no longer where Wallace thought he was. Moreover, he had been pushed back so far that Wallace now found himself in the rear of the advancing Southern troops. Nevertheless, a messenger from Grant arrived with word that Grant was wondering where Wallace was and why he had not arrived at Pittsburg Landing, where the Union was making its stand. Wallace was confused. He felt sure he could viably launch an attack from where he was and hit the Rebels in the rear. Nevertheless, he decided to turn his troops around and march back to Stoney Lonesome. For some reason, rather than realigning his troops so that the rear guard would be in the front, Wallace chose to countermarch his column; he argued that his artillery would have been greatly out of position to support the infantry when it would arrive on the field.

Wallace marched back to Stoney Lonesome, and arrived at 11 a.m. It had now taken him five hours of marching to return to where he started, with somewhat less rested troops. He then proceeded to march over the lower road to Pittsburg Landing, but the road had been left in terrible conditions by recent rainstorms and previous Union marches, so the going was extremely slow. Wallace finally arrived at Grant's position at about 7 p.m., at a time when the fighting was practically over. Grant was not pleased. Nevertheless, the Union came back to win the battle the following day. Wallace's division held the extreme right of the Union line and was the first to attack on April 7.At first, there was little fallout from this. Wallace was the youngest general of his rank in the army and was something of a "golden boy." Soon, however, civilians in the North began to hear the news of the horrible casualties at Shiloh, and the Army needed explanations. Both Grant and his superior, Halleck, placed the blame squarely on Wallace, saying that his incompetence in moving up the reserves had nearly cost them the battle. Sherman, for his part, remained mute on the issue. Wallace was removed from his command in June and reassigned to the much less glamorous duty commanding the defense of Cincinnati in the Department of the Ohio during Braxton Bragg's incursion into Kentucky.

Later service

Wallace's most notable service came in July 1864, at the Battle of Monocacy, part of the Valley Campaigns of 1864. Although the some 5,800-man force under his command (mostly hundred-days' men amalgamated from the VIII Corps) and the division of James B. Ricketts from VI Corps was defeated by Confederate General Jubal A. Early, who had some 15,000 troops, Wallace was able to delay Early's advance for an entire day toward Washington, D.C., to the point that the city defenses had time to organize and repel Early, who arrived at Fort Stevens in Washington at around noon on July 11, two days after defeating Wallace at Monocacy, the northernmost Confederate victory of the war.

General Grant relieved Wallace of his command after learning of the defeat of Monocacy, but re-instated him two weeks later. Grant's memoirs praised Wallace's delaying tactics at Monocacy: "If Early had been but one day earlier, he might have entered the capital before the arrival of the reinforcements I had sent. ... General Wallace contributed on this occasion by the defeat of the troops under him, a greater benefit to the cause than often falls to the lot of a commander of an equal force to render by means of a victory." Personally, Wallace was devastated by the loss of his reputation as a result of Shiloh. He worked desperately all his life to change public opinion about his role in the battle, going so far as to literally beg Grant to "set things right" in Grant's memoirs. Grant, however, like many of the others Wallace importuned, refused to change his opinion.

Wallace participated in the military commission trial of the Lincoln assassination conspirators as well as the court-martial of Henry Wirz, commandant of the Andersonville prison camp. He resigned from the army on November 30, 1865. Late in the war, he directed secret efforts by the government to help the Mexicans remove the French occupation forces who had seized control of Mexico in 1864. He continued in those efforts more publicly after the war and was offered a major general's commission in the Mexican army after his resignation from the U.S. Army. Multiple promises by the Mexican revolutionaries were never delivered, which forced Wallace into deep financial debt.

Wallace held a number of important political posts during the 1870s and 1880s. He served as governor of New Mexico Territory from 1878 to 1881, and as U.S. Minister to the Ottoman Empire from 1881 to 1885. As governor, he offered amnesty to many men involved in the Lincoln County War; in the process he met with Billy the Kid. On March 17, 1879, the pair arranged that the Kid would act as an informant and testify against others involved in the Lincoln County War, and, in return, the Kid would be "scot free with a pardon in [his] pocket for all [his] misdeeds". Wallace, facing the political forces then ruling New Mexico, was unable to come through on his end of the bargain and The Kid returned to being an outlaw.

While serving as governor, Wallace completed the novel that made him famous: A Tale of the Christ (1880). It grew to be the best-selling American novel of the 19th century. The book has never been out of print and has been filmed four times. Historian Victor Davis Hanson argued that the novel was based heavily on Wallace's own life, particularly his experiences at Shiloh and the damage it did to his reputation. There are some striking similarities: the book's main character, Judah Ben-Hur, accidentally causes injury to a high-ranking commander, for which he and his family suffer no end of tribulations and calumny.

The General Lew Wallace Study in Crawfordsville, Indiana, was built from 1895 to 1898. It was near Wallace's residence, and he designed it himself. It is now a museum open to the public.

Wallace died, likely from cancer, in Crawfordsville and is buried there in Oak Hill Cemetery. A marble statue of him dressed in a military uniform by sculptor Andrew O'Connor was placed in the National Statuary Hall Collection by the state of Indiana in 1910 and is currently located in the west side of the National Statuary Hall.