The lambda is converted into an Expression, basically a syntax tree, which is then analyzed to see what is accessed.

Ok, so its a step in the compile that rewrites and analyzes it?

It's actually really neat. Normally a lambda would just be a function but if it gets cast to an Expression then you get the AST at runtime. Entity Framework analyzes these at runtime to generate the SQL and logic/mapping etc. You can get the AST at compile time in some situations with a Roslyn plug-in or etc I believe as well.

The C# compiler is looking at that code. It sees that the lambda is being passed into a function which accepts an Expression as a parameter, so it compiles the lambda as an expression tree rather than behaving like it's a normal delegate.