The US has joined 30 other nations in formally recognising Libya's main opposition group as the country's legitimate government until a new interim authority is created.
Friday's decision, which declared Muammar Gaddafi's government no longer legitimate, will potentially free up money that the rebels fighting the Libyan leader's forces urgently need.
The final statement by the so-called Contact Group on Libya, meeting in the Turkish city of Istanbul, said the "Gaddafi regime no longer has any legitimate authority in Libya", and Gaddafi and certain members of his family must go.
The group said it would deal with Libya's main opposition group - the National Transitional Council, or NTC - as "the legitimate governing authority in Libya" until an interim authority is in place.
Gaddafi rejected the Contact Group's decision on Libyan televison.
In an audio speech, he told thousands of supporters in the town of Zlitan: "Trample on those recognitions, trample on them under your feet ... They are worthless."
Al Jazeera's Barnaby Phillips, reporting from Istanbul, said: "The main focus is ways to get rid of Gaddafi as quickly as possible, and to look at what will come next.
"Previous meetings focused more on bolstering NATO's military efforts and aid to civilians."
In addition to the US, the 32-nation Contact Group on Libya includes members of NATO, the European Union and the Arab League.
The front lines in the Libyan civil war have largely stagnated since the popular uprising seeking to oust Gaddafi broke out in February.
Rebels, backed by NATO's aerial bombings, control much of the country's east and pockets in the west. But Gaddafi controls the rest from Gaddafi's stronghold in Tripoli, the capital.
The recognition of the Libyan opposition as the legitimate government gives the anti-Gaddafi coalition a major financial and credibility boost.
Anita McNaught reports from Benghazi on the significance of the Contact Group's statement for the Libyan opposition coalition
Diplomatic recognition of the council means that the US will be able to fund the opposition with some of the more than $30bn in Gaddafi-government assets that are frozen in American banks.
"The United States views the Gaddafi regime as no longer having any legitimate authority in Libya," Hillary Clinton, the US secretary of state, said.
"And so I am announcing today that, until an interim authority is in place, the United States will recognise the TNC as the legitimate governing authority for Libya, and we will deal with it on that basis."
The Contact Group representatives broke into spontaneous applause when Clinton announced that the US recognises the NTC, according to US officials.
Mahmoud Shammam, an NTC spokesman, welcomed the decision, calling on other nations to deliver on a promise to release hundreds of millions of dollars in funds to the Libyan opposition.
"Funds, funds, funds," Shammam said in order to stress the opposition's demand.
He said the opposition hopes to hold elections within a year and resume oil exports very soon, saying the damage to oil facilities have been minimal and repaired. However, Shammam ruled out any new oil contracts until a new elected government was in place.
Dying for oil
From Tripoli, Moussa Ibrahim, the spokesman for the Libyan government, said its members were ready to die in defence of the country's oil against attacks by the rebels and NATO forces.
"We will kill, we will die for oil," he said.
"Rebels, NATO, we don't care. We will defend our oil to the last drop of blood and we are going to use everything."
Rosiland Jordan reports from Washington on the delayed recognition by the US of the Libyan opposition NTC
There had been concerns about whether the initial government would represent the full spectrum of Libyan society, and Human Right Watch called on the Contact Group on Libya to press the opposition to ensure that civilians are protected in areas where rebels have assumed control.
The organisation cited abuses in the four towns of Awaniya, Rayayinah, Zawiyat al-Bagul, and Qawalish - recently captured by rebels in the western mountains, including looting, arson and beatings of some civilians who remained when government forces withdrew.
The US official, however, said the NTC won international recognition after it said it would abide by its commitments and find a way forward for a truly democratic Libyan government.
The assurances included upholding the group's international obligations, pursuing a democratic reform process that is both geographically and politically inclusive, and dispersing funds for the benefit of the Libyan people.
The Contact Group statement urged a smooth transition to democracy and ruled out participation of "perpetrators of atrocities against civilians" in a future political settlement.