The movie begins with Grace Stewart (Nicole Kidman
) waking up from a nightmare. It is 1945 in Jersey, and her husband was fighting in France but he has yet to return home, even though the war has ended. She lives in a big, creepy house alone with her two kids, Anne (Alakina Mann
) and Nicholas (James Bentley
). Recently, around a week or two ago, all the servants just upped and abandoned them, without a word or collecting their wages.
Three servants-- mute Lydia (Elaine Cassidy
), Mr. Tuttle (Eric Sykes
), and Mrs. Bertha Mills (Fionnula Flanagan
)-- come to her door, to respond to an ad that Kidman had posted for new servants. They are all shown around the house by Grace, who explains the rules... one must never open a door without closing the previous one, and the drapes must always be shut because her children are "photosensitive"-- they break out in rashes and sores if they are exposed to light stronger than candlelight.
One day, Grace goes to the mailbox and sees that the letters she'd sent out to the newspaper announcing positions are still there. She confronts Mrs. Mills angrily, demanding to know who they are.. and how did they know of the jobs if the ad hasn't even come out yet? Mrs. Mills then tells Grace that all three of them had used to live in the house, and had loved it so much that they come back to see if they could be of any use, as a house as big as Kidman's always needs extra help. When she welcomed them thinking they had answered to the ad, they just did not want to tell her otherwise.
Strange things happen in the house. Sometimes, there are people talking and whispering and crying; thuds and noises come from empty rooms; Ann talks to an invisible boy, Victor (Alexander Vince
), and insists that there are others walking around the house. Grace refuses to believe her, and frequently tells her to stop and punishes her for "lying"; Mrs. Mills assures Anne that she believes her and that soon her mother will see. Mrs. Mills then tells Grace that sometimes the world of the living gets mixed up in the world of the dead. Grace refuses to believe until one day, she is sewing Anne's first communion veil when she heard thuds upstairs; she races to investigate but there's no one there, and she sees in the mirror that the door is closing all by itself. Grace then goes on a hunt to seek out the intruders, enlisting her whole household (and this is the first of two or three such hunts)... she then wants her house blessed so she goes out to find the priest.
Mrs. Mills races after her and tells her not to go; Grace leaves and Mrs. Mills talks to Mr. Tuttle, who's doing the lawn work; she says that eventually it'll all come out and tells him to hide these gravestones on the property. Grace gets lost in the mist and she finds her husband (Christopher Eccleston
), who looks lost and very out of it, and brings him home. He won't speak or do anything except for staying in bed. Now Grace, who'd previously started to believe in the "intruders," revert back into stubbornness. Her daughter shows her the picture she'd drawn, of Victor and his parents (including a pianist father who played the piano invisibly one night) (Keith Allen
& Michelle Fairley
) and of the old woman, with sightless eyes. In one of her hunts for the "intruders" Kidman finds a book of photography, including this book in which there are people posed and "sleeping"-- until Mrs. Mills tells them that those people are dead, and that it's a book of the dead, which the superstitious believed would guard the souls of those dead.
Grace and her daughter are putting the finishing touches on her communion dress when Grace has to leave for a moment. She comes back and is horrified to see that not only is her daughter sitting on the floor in her spotless dress, but she's become this creepy old woman-- so she grabs her daughter in a chokehold and starts to scream and hit her. The veil rips off to reveal that it is her daughter, crying; she then runs away. Grace is shaken as she thinks she's gone mad. Then going back to her husband's room, he tells her that Ann has told him of what had happened a week ago. Grace breaks down and cries and protests that it wasn't her fault; but then he tells her that he has to leave and she knows that for all of her excuses he needs something beyond her family and herself. Furthermore, her husband, who had come from within the fog dazzled and confused, finally goes away, saying that he must return to the war. Grace had told him that the war was over, to no avail: he leaves anyway.
So he leaves, and the next morning the curtains are gone. The children are screaming and Grace Stewart is demanding from her three servants hysterically where they are; she even grabs a gun and threaten them and tells them to leave, because they're not helping her and they must have stolen the curtains. The children go to bed but they then climb out the window because they want to look for their father and they're kind of scared of their mother. Grace is ripping apart the house looking for curtains; she goes into the servants' rooms and finds an envelope on the bed, containing a photograph of Mr. Tuttle, Lydia, and Mrs. Mills, inscribed 1891, from the book of the dead.
The mists are surrounding the island when Ann comes across the gravestones of the three servants, and then she sees them in the distance. They're approaching her and Nicholas, and they both run into the house with the servants following; Grace is there and she locks them out, and tells her children to hide while she fends them off. Mrs. Mills then tells Grace from outside the doors that it's too late, now she has to go and find them herself. Meanwhile, Nicholas and Ann run upstairs into a wardrobe, and hide but the door is thrown open to reveal a white-haired old lady with opaque eyes (Renée Asherson
)... and everyone screams, including Grace who has run upstairs by now.
The camera then turns to a group of people who are sitting around a table, including the old lady, now acting as the speaker of the seance. She is asking the children why they are lingering around in death? Ghostly Ann and ghostly Nicholas scream that they aren't dead, while ghostly Grace is grabbing the paper and tearing them apart, screaming too, and shaking the table, trying to get the speakers' attention. We see that the papers are flying up by themselves and that the table is shaking but don't see Grace and the kids: we can see only the startled participants of the seance, watching the blind lady scrubbling like crazy on a piece of paper in a rapture. It then stops and the old woman is snapped out of the trance.
We discover what had really happened: Grace had smothered her children in their sleep, and then shot herself ("a week or two ago, the servants disappeared -- because their employer, Grace, had died"); The present occupants of the house are the pianist father (Keith Allen), mother (Michelle Fairley), and the child Victor Marlish (Alexander Vince) They three will eventually leave the house due to the hauntings of Grace and her children. The three servants had died in the TB epidemic half a century ago, and somehow, everyone still lives in the house, the living side by side with the dead. Grace admits to having done it. The next morning, when she found herself alive again and the children pillow-fighting, she thought it was another opportunity for her to become a good mother, as if her terrible actions had only been a nightmare.
The movie ends as the occupants, unable to rid the house of Grace and the kids, drive away with Grace watching from an upstairs window. The sign on the gate says the house is For Sale. Grace says that she and her children will never leave the house, as they belong there.