Deir Ezzor, in eastern Syria, remains largely under IS control even as the group is losing territory elsewhere in the country.
The US-led coalition fighting IS in Syria and Iraq said it could not confirm the report.
"Top tier commanders from IS who are present in Deir Ezzor province have confirmed the death of Abu Bakr al-Baghdadi, emir of the Islamic State group, to the Observatory," the monitor's director Rami Abdel Rahman told AFP.
"We learned of it today but we do not know when he died or how."
Deir Ezzor, in eastern Syria, remains largely under IS control even as the group is losing territory elsewhere in the country and in neighbouring Iraq.
Abdel Rahman said Baghdadi "was present in eastern parts of Deir Ezzor province" in recent months, but it was unclear if he was killed in the area or elsewhere.
There was no official confirmation or denial of the news on social media platforms used by IS.
The US-led coalition said it could not verify the Observatory's report.
"We cannot confirm this report, but hope it is true," said coalition spokesman Colonel Ryan Dillon.
"We strongly advise ISIS to implement a strong line of succession, it will be needed," he added, using a different acronym for IS.
There have been persistent rumours of Baghdadi's death in recent months, and Russia's military said in mid-June that it was seeking to verify whether it had killed the IS chief in an air strike in Syria in May.
Russia's army said Sukhoi warplanes carried out a 10-minute raid on May 28 at a location near the IS stronghold of Raqa, where group leaders had gathered to plan a pullout from the area.
The US-led coalition also said at the time it could not confirm whether the Russian strike had killed Baghdadi.
The 46-year-old Iraqi-born leader of IS has not been seen in public since making his only known public appearance as "caliph" in 2014 at the Grand Mosque of Al-Nuri in Mosul.
IS destroyed the highly symbolic site before Iraqi forces could reach it as they pushed the jihadist group from Mosul, where Iraq's government formally declared victory on Monday.
With a $25-million US bounty on his head, Baghdadi has kept a low profile and was rumoured to move regularly throughout IS-held territory in the area straddling Iraq and Syria.
His death, if confirmed, would be another heavy blow to the group which is also battling a US-backed coalition of Kurdish and Arab fighters for control of its Syrian stronghold Raqa.