Newsweek Editor Mark Whitaker told journalists on Monday he was retracting the "original story that an internal military investigation had uncovered Quran abuse".
The retraction came as the White House, the Pentagon and the State Department all heavily criticised the report and said it had damaged the US image abroad.
White House spokesman Scott McClellan said it was "puzzling" that Newsweek had not retracted the story a day after apologising for it.
"A retraction is a good first step," McClellan said after Newsweek issued its statement.
"This allegation was unsubstantiated and it was contrary to everything that we value and all that our military works to uphold. We encourage Newsweek to now work diligently to help undo what damage can be undone."
"People lost their lives. The image of the United States abroad has been damaged. It will take work to undo what can be undone," McClellan said.
The Pentagon said earlier an investigation remained open into allegations contained in Newsweek's 9 May report.
The report sparked violent protests across the Muslim world - from Afghanistan, where 16 were killed and more than 100 injured, to Pakistan, Indonesia and Gaza.
In the past week, the reported desecration was condemned in Egypt, Saudi Arabia, Bangladesh, Malaysia and by the Arab League.
Afghan policemen and ISAF
soldiers had to put down riots
State Department spokesman Richard Boucher said it was appalling that "an article that was unfounded to begin with has caused so much harm, including loss of life."
The US image has already been tarnished in many parts of the Arab world, and Washington has laboured to rebuild trust among Muslims following last year's disclosures that US guards at Baghdad's Abu Ghraib prison physically and sexually abused Iraqi prisoners.
Newsweek said in its 23 May edition that the information came from a "knowledgeable government source" who said a military report on abuse at Guantanamo Bay had found that interrogators flushed at least one copy of the Quran down a toilet in a bid to make detainees talk.
But the source later told the magazine he could not be certain he had seen an account of the Quran incident in the military report and that it might have been in other investigative documents or drafts, Newsweek said.
A conservative media watchdog group, Accuracy in Media, (AIM) said in a news release that "blood is on the hands of Newsweek magazine" for the story. AIM editor Cliff Kincaid expressed incredulity that "nobody at Newsweek has been fired or even reprimanded".
Pentagon spokesman Bryan Whitman was asked whether the Pentagon could say definitively that US personnel never threw a Quran in a toilet at Guantanamo.
"You know, I never get into the business of saying never," Whitman said. "What I'm saying is that this allegation that Newsweek made ... about Quran desecration is demonstrably false. And there have, thus far, been no credible allegations of willful Quran desecration."