Corporal Dustin Berg, 22, will spend 18 months in prison and receive a bad conduct discharge from the US Army.
Berg had changed his story multiple times during the investigation, initially saying the Iraqi had pointed an AK-47 rifle at him.
On Monday, however, Berg said that Iraqi police officers as a matter of habit carried their guns with the barrels pointed slightly upward.
"I shouldn't have automatically considered him a threat," Berg said during his trial at Fort Knox in Kentucky. "I misread the situation."
It was the latest in at least a dozen courts martial of US troops accused in the deaths of Iraqi civilians.
Berg was accused of killing the Iraqi police officer in November 2003, then shooting himself in the stomach to give the impression of a gunfight and to block an investigation.
"I thought I was going to die," Berg testified during a May hearing. "I felt I had no choice but to fear for my life."
He later acknowledged that he shot himself with the Iraqi's weapon in an attempt to limit questions since there were no witnesses. Three other soldiers from his unit were under investigation at the time, and Berg said he was scared he would be, too.
"He's already punished himself. He shot himself. He's already pleaded guilty"
Prosecutors had asked that Berg receive a dishonourable discharge from the army and nearly four years in confinement. He had faced up to 14 years in prison.
Berg's civilian attorney, Charles Gittins, asked the court to discharge Berg but not confine him to a military prison because Berg was newly married and had a child on the way.
"He's already punished himself. He shot himself. He's already pleaded guilty. He's already accepted responsibility. But a lengthy term of confinement will have no rehabilitative effect," Gittins said.
The charges against Berg raised questions about whether a soldier's right to defend himself depends on the presence of a witness.
Most military personnel accused of murder argue self-defence because there are few other options available on the battlefield, said Gary Solis, a law professor at the US Military Academy at West Point.
Soldiers can claim they were acting in self-defence or that they were following orders, Solis said.
At least eight US soldiers have been convicted or have pleaded guilty to charges stemming from the deaths of Iraqis.