Inmates in the Pavon correctional facility lived in spacious houses built in the prison's grounds and ran drug and extortion rackets on the outside via mobile phones.
The prison guards, most of whom were corrupt, patrolled only the perimeter and ran the administration section of the prison.
About 3,000 police and soldiers stormed Pavon just after dawn and clashed with prisoners who fired assault rifles and threw grenades.
Carlos Vielmann, the interior minister, told reporters: "There was initial resistance by the inmates which was controlled in less than an hour."
Luis Alfonso Zepeda, a convicted murderer who headed a prisoners' committee that controlled the jail, was killed in a shootout.
Zepeda earned around $25,000 a month from extortion and drug trafficking run from inside the prison, police said. His son Samuel lived illegally inside the prison to help run the crime empire, even though he was never sent there by a court.
Drugs and alcohol
Prisoners had set up laboratories to produce drugs and alcohol inside Pavon.
Vielmann said: "It's a centre where organised crime, drug trafficking, kidnapping, extortion and all kinds of illicit activities were being controlled from."
Violent deaths are common in Guatemala's crumbling prisons, where common criminals, rival "mara" street gangsters and drug traffickers often battle for control.
The operation came a day after Guatemala's main newspaper Prensa Libre published a long article about the prisoners' often relaxed lifestyle.
Prison officials said some inmates had their own computers and fridges. Many of the guards left the prisoners to their own devices.
Security forces began emptying the prison of its 1,600 inhabitants and transferring them to another prison.
Pavon, southeast of the capital, was originally built for 800 inmates as a farm prison, where prisoners could grow their own food. But its population grew over time and inmates began to construct their own homes on the grounds.
Some prisoners even sold title deeds of homes to new inmates, police said.