Essential oils extracted from the heartwood of Indian sandalwood (Santalum album L.) contain linalool and nerolidol as minor components. However, nerolidol/linalool synthase (NES/LIS), which produce linalool and nerolidol, have yet to be characterized in sandalwood. Using a transcriptomic-based approach, a terpene synthase gene was screened from unigenes of transcriptome data derived from S. album seedlings exposed to low temperature (4 °C). The enzyme encoded by these complementary DNAs belongs to the TPS-b clade. Recombinant SaNES/LIS is a bifunctional enzyme that can catalyze the formation of (E)-nerolidol from farnesyl diphosphate and linalool from geranyl diphosphate, respectively. Whereas SaNES/LIS was primarily localized in chloroplastids, both as granular fluorescence and as diffuse fluorescence, it was also detected in the cytosol of a limited number of cells. Agrobacterium tumefaciens-mediated transient gene expression in planta produced the same terpene products as those obtained in vitro. Real-time PCR analysis showed the highest expression of SaNES/LIS in fruits, with about a three-fold higher level than in leaves, followed by flowers, heartwood and roots. SaNES/LIS transcripts were differentially activated in different tissues in response to methyl jasmonate, cold, high temperature, strong illumination, and drought stress. Our results provide novel insight into the role of sandalwood terpenoids in response to various environmental stresses.