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This paper proposed a prewhitening invariance of noise space (PW-INN) as a new magnetoencephalography (MEG) source analysis method, which is particularly suitable for localizing closely spaced and highly correlated cortical sources under real MEG noise. Conventional source localization methods, such as sLORETA and beamformer, cannot distinguish closely spaced cortical sources, especially under strong intersource correlation. Our previous work proposed an invariance of noise space (INN) method to resolve closely spaced sources, but its performance is seriously degraded under correlated noise between MEG sensors. The proposed PW-INN method largely mitigates the adverse influence of correlated MEG noise by projecting MEG data to a new space defined by the orthogonal complement of dominant eigenvectors of correlated MEG noise. Simulation results showed that PW-INN is superior to INN, sLORETA, and beamformer in terms of localization accuracy for closely spaced and highly correlated sources. Lastly, source connectivity between closely spaced sources can be satisfactorily constructed from source time courses estimated by PW-INN but not from results of other conventional methods. Therefore, the proposed PW-INN method is a promising MEG source analysis to provide a high spatial-temporal characterization of cortical activity and connectivity, which is crucial for basic and clinical research of neural plasticity. [ABSTRACT FROM AUTHOR]