Despite warnings from Arab, Muslim and Western allies, the US President instructed the State Department to begin the process of moving the American embassy from Tel Aviv to the holy city.
Mr Trump said ahead of the announcement that his decision on Jerusalem was "long overdue" step to advance the peace process.
"I have determined that it is time to officially recognise Jerusalem as the capital of Israel," he said. "While previous presidents have made this a major campaign promise, they failed to deliver. Today, I am delivering."
Mr Trump acted under a 1995 law that requires the United States to move its embassy to Jerusalem. His predecessors, Bill Clinton, George W Bush and Barack Obama, had consistently put off that decision to avoid inflaming tensions in the Middle East.
A Palestinian envoy said Mr Trump's decision was a declaration of war in the Middle East while Pope Francis called for Jerusalem's status quo to be respected, saying new tension would further inflame world conflicts.
China and Russia expressed concern that the plans could aggravate Middle East hostilities. The United States has never endorsed the Israel's claim of sovereignty over any part of Jerusalem and has insisted its status be resolved through Israeli-Palestinian negotiation.
Any US declaration on Jerusalem's status ahead of a peace deal "would harm peace negotiation process and escalate tension in the region," Saudi Arabia's King Salman told Mr Trump, according to a Saudi readout of their telephone conversation.
Declaring Jerusalem as Israel's capital, the King said, "would constitute a flagrant provocation to all Muslims, all over the world."
In his calls to Palestinian President Mahmoud Abbas and Jordan's King Abdullah II, Mr Trump delivered what appeared to be identical messages of intent.
Both leaders warned him moving the embassy would threaten peace efforts and security and stability in the Middle East and the world, according to statements from their offices.
Ahmed Aboul-Gheit, the head of the Arab League, urged the US to reconsider any recognition of Jerusalem as Israel's capital, warning of "repercussions."
Turkey's President, Recep Tayyip Erdogan, told his Parliament such recognition was a "red line" for Muslims and said Turkey could respond by cutting diplomatic ties with Israel.
The French President, Emmanuel Macron, said he reminded Mr Trump in a phone call that Jerusalem should be determined through negotiations on setting up an independent Palestine alongside Israel.
Meeting US Secretary of State Rex Tillerson in Brussels, EU foreign policy chief Federica Mogherini said actions undermining peace efforts "must be absolutely avoided."
Additional reporting by agencies