Capping weeks of negotiations, the council voted 15-0 in favour of a resolution endorsing the sovereignty of the new Baghdad government that will take power on 30 June and pave the way for democratic elections next year.
Tuesday's vote also gives a mandate to US-led occupation forces until the end of January 2006, authorising them to "use all necessary measures" to retain control.
Iraq's new interim president Ghazi al-Yawar welcomed the result.
"It means full sovereignty for Iraq. It means a new age in hopefully very pleasant Iraqi history."
The vote came as President George Bush opened a three-day summit of eight of the world's most industrialised nations.
"The vote today in the United Nations Security Council was a great victory for the Iraqi people," Bush said after a meeting with Russian President Vladimir Putin, an opponent of the Iraq invasion.
Putin also welcomed the deal. "Without any exaggeration I would state that it is a major step forward.
"Naturally, it will take quite a long time before this adoption of the document will have any impact on the real change on the ground in Iraq."
German Chancellor Gerhard Schroeder, a critic of the war on Iraq, said the resolution would bring "more stability" to the country and give the Iraq people "more of a chance".
European Commission chief Romano Prodi remained cautious about the eventual impact of the resolution.
"[The resolution] has to be judged on its capacity to create a new situation with respect to the chaos, not necessarily tomorrow morning but reasonably soon"
European Commission chief
He said "it has to be judged on its capacity to create a new situation with respect to the chaos, not necessarily tomorrow morning but reasonably soon".
Point of contention
The extent of Baghdad's control over military operations had emerged as the main sticking point in negotiations, with the United States and Britain rejecting a call by France and others to give Iraq a veto over major offensives.
But Washington offered a compromise in council talks on Monday, adding a pledge to coordinate policy on "sensitive" military operations with a national security committee headed by Iraqi PM Iyad al-Allawi.
The resolution authorises US-led troops to remain at Iraq's request, and gives them leeway to take "all necessary measures" in fighting the bloody insurgency that has undercut the US-led occupation's efforts to stabilise the country.
Under the deal Iraq has the authority to request the departure of the roughly 150,000 US-led troops.