Donald Trump described the move as "a long overdue step" to advance the Middle East peace process, reports BBC online Wednesday.
The fate of the ancient city is one of the thorniest issues between Israel and the Palestinians.
Mr Trump said the US still supported a two-state solution to the longstanding conflict, if approved by both sides, which would essentially see the creation of an independent Palestinian state living alongside Israel.
Palestinian President Mahmoud Abbas called Mr Trump's announcement "deplorable", saying the US could no longer be a peace broker.
The decision to recognise Jerusalem as Israel's capital puts the US at odds with the rest of the international community's view on Jerusalem's status.
The Palestinians claim East Jerusalem as the capital of a future state, and according to the 1993 Israel-Palestinian peace accords, its final status is meant to be discussed in the latter stages of peace talks.
Israeli sovereignty over Jerusalem has never been recognised internationally, and until now all countries have maintained their embassies in Tel Aviv.
Jerusalem contains sites sacred to the three major monotheistic faiths - Judaism, Islam and Christianity. East Jerusalem, which includes the Old City, was annexed by Israel after the Six Day War of 1967.
The decision fulfils a campaign promise and appeals to Mr Trump's right-wing base, BBC notes.