She said she left the party “in better shape than I found it”, after taking on the job in the wake of the 2015 general election, which saw Labour lose all but one of its MPs in Scotland while the SNP enjoyed a landslide victory.
With four years to go until the next Holyrood elections, Ms Dugdale said: “I am convinced that the party needs a new leader with fresh energy, drive and a new mandate to take the party into that contest.”
Jeremy Corbyn, who she campaigned against in the 2016 party leadership contest, paid tribute to her for taking on the job of Scottish leader at “one of the most difficult times” in Labour’s history north of the border.
Labour managed to win back some of the seats it had lost the Nicola Sturgeon’s SNP in the June 2017 snap general election, with the party now having seven MPs from Scotland.
Mr Corbyn said: “I’d like to thank Kezia Dugdale for her work as Scottish Labour leader and the important role she has played in rebuilding the party in Scotland.
“Kezia became Scottish leader at one of the most difficult times in the history of the Scottish Labour Party, and the party’s revival is now fully under way, with six new MPs and many more to come.
“I want to thank Kez for her tireless service to our party and movement, and look forward to campaigning with her in future for a country that works for the many not the few.”
Ms Dugdale becomes the third Scottish Labour leader to have resigned since the 2014 independence referendum, after Johann Lamont and Jim Murphy, while Anas Sarwar and Iain Gray have also served as acting leader since the vote on Scotland’s future.
Ms Sturgeon, Scotland’s First Minister, wished Ms Dugdale well for the future, writing on Twitter: “We may be opponents, but @kezdugdale led her party with guts and determination and I admired her for that.”
In her resignation letter to Scottish Labour Party chairwoman Linda Stewart, Ms Dugdale insisted she was leaving the party “in better shape than I found it.”
She added: “Emerging from the challenging times following the 2014 referendum, and the 2015 UK election, we now have a solid platform on which to build towards success, and government.”
With the constitutional battleground having defined Scottish politics in recent years, Ms Dugdale has sought to give Labour a distinct position, with the party now supporting a federal UK.
She pressed Scottish ministers to use new powers over income tax north of the border to raise extra revenue, calling for a return of the 50p top tax rate for high earners and a 1p rise in the basic rate.
In her time as leader there was speculation of a leadership challenge from the left, but Ms Dugdale denied she was quitting before she was pushed.
She stated: “Too often our leaders leave in a crisis, with scores to settle. I love this party too much for that to be my way. There will be no press conference and no off the record briefing in my name.
“I choose to stand down because I believe it is best for me and best for Scottish Labour, at a time when we can be positive and optimistic about our future.”
She added: “I remain in awe of all those party activists who devote their time to this movement without pay or reward. I thank them for their belief in me.”
Ms Dugdale will continue as an MSP for the Lothian region, with deputy leader Alex Rowley set to take charge of the party in Scotland until her successor is found.
Her resignation came the day after her 36th birthday, with Ms Dugdale saying being leader had been “a difficult but fulfilling challenge”.
Referring to the death of Labour activist and Motor Neuron Disease campaigner Gordon Aikman earlier this year, Ms Dugdale said she had “lost a dear friend who taught me a lot about how to live”.
She continued: “His terminal illness forced him to identify what he really wanted from life, how to make the most of it and how to make a difference. He taught me how precious and short life was and never to waste a moment.”
Former Labour leader Ed Miliband thanked Ms Dugdale for her work, and said she gave her “heart and soul to leading Scottish Labour”.
He tweeted: “Thank You. You deserve to get your life back. Enjoy.”
During Ms Dugdale’s time in charge Labour has become the third party in Scotland, with Ruth Davidson’s Scottish Conservatives now having more MSPs and more MPs.
Ms Davidson said on Twitter: “’Leadership can be tough and @kezdugdale deserves the thanks of her party for putting in the hard yards. I wish her well.’’
Meanwhile Scottish Secretary David Mundell said: ‘’Today as always @kezdugdale has shown she is a person of character and substance. I wish her well, but hope she stays in frontline politics.’’
Patrick Harvie, the co-convener of the Scottish Greens, said Ms Dugdale had “served her party with dedication”.
He added: “Her decision to stand down can’t have been easy. I’d like to wish her well for the future.”
Scottish Liberal Democrat leader Willie Rennie said: “Kezia Dugdale has been a good thing for Labour. Her open, friendly, and upbeat style was appealing. I enjoyed working with her on common causes and hope that will continue. I wish her well for the future.”