After Ne Zha and Ao Bing are struck by heavenly lightning together, their physical bodies are destroyed. To prevent their souls from dissipating, Master Taiyi Zhenren exhausts his Seven-colored Sacred Lotus to regenerate their physical bodies, though they are still fragile. Ao Bing’s father Ao Guang, the Dragon King of the East Sea, believing his son is dead, attacks the town, releasing the monsters imprisoned under his palace, including the other three Dragon Kings of the Four Seas. Ao Bing defends Chentang Pass, but due to the effort exerted, his new body disintegrates.

Ao Guang makes a ceasefire deal: Ao Bing and Ne Zha will share Ne Zha’s body for seven days, complete Immortal Wuliang’s three trials for ascending to xian, and win a potion that will restore the Sacred Lotus and create a new body for Ao Bing; after that, Ao Guang’s forces will retreat. In the trials, candidates complete missions supervised by and normally performed by the heavenly Taoist sect’s demon-hunting forces. Ne Zha takes a sleeping pill to hide his demonic nature, allowing Ao Bing to fully control his body temporarily. They beat the first two trials against a marmot bandit clan and a master who trains demons to prepare for the xian trials, respectively.

In the meantime, Ao Guang tasks Master Shen Gongbao—a Leopard demon who has ascended to the sect’s court—to supervise Chentang Pass and the other three Dragon Kings. Gongbao is unexpectedly reunited with his younger brother, Shen Xiaobao, who tells him of the sect’s siege and plunder of the Shen family’s village—including Ne Zha’s battle against the master, who is their father. Xiaobao dies in Gongbao’s arms, having been mortally wounded in his attempt to protect his father during Ne Zha’s second trial. While the sect prepares for the next trial, Chentang Pass is massacred by the dragons. Enraged, Ne Zha completes the third trial without Ao Bing’s help, becoming xian and winning the potion. As Taiyi regenerates Ao Bing’s body, Ne Zha abandons them to join Wuliang’s forces in trapping the dragons in the sect’s cauldron, where the dragons will be forged into elixirs as vengeance for Chentang Pass’ destruction.

Ne Zha’s parents arrive at the cauldron unharmed with Ao Bing and Master Taiyi to explain the truth. In a flashback, Wuliang attacks Chentang Pass. Gongbao deduces Wuliang’s role in besieging the Shen family, only for the three Dragon Kings to betray their kind and join Wuliang. They massacre the townspeople and frame Ao Guang as a casus belli to destroy the dragons and ensure the heavenly sect’s domination. Gongbao takes a last stand to defend the city, buying enough time to arrange for Ne Zha’s parents’ survival.

The two parties battle until Wuliang manages to cast Ne Zha’s group into the cauldron. Ne Zha’s mother dies in her son’s arms. Enraged, Ne Zha absorbs the cauldron’s samadhi fire, fully solidifying his new body. With the help of the dragons and prisoners, Ne Zha and Ao Bing break the cauldron. United, they force the heavenly forces to retreat. In the aftermath, Ao Guang leads the remaining dragons into hiding in the sea, with the exception of Ao Bing, who stays behind to help expose Wuliang’s nature.

In a post-credits scene, Wuliang heads to a secret prison to negotiate with the captive Shen Gongbao and Shen’s father, hoping to recruit them. However, they end up stuck in the prison for 10 years when Wuliang hypnotizes the prison guard to go to sleep. Ne Zha’s older xian brothers are also summoned to meet with Wuliang.