Contracts with 13 private prisons will be reviewed and and allowed to expire over the next five years.
“They do not save substantially on costs and … they do not maintain the same level of safety and security,” Deputy Attorney General Sally Yates said explaining the decision.
The majority of US prisoners are held in state-run prisons.
On Wall Street, the stocks of private prison companies declined sharply after the news was announced.
By Thursday afternoon, Corrections Corporation of America stock had plunged by nearly 50%.
An Inspector General’s report released this month found that private prisons saw higher rates of violent incidents and rule infractions in comparison with government-run institutions.
Jonathan Burns, a spokesman for the Corrections Corporation of America, told BBC News that the report contained “significant flaws” and that other studies have shown their facilities “to be equal or better with regard to safety and quality”.
David Fathi, who directs the National Prison Project for the American Civil Liberties Union (ACLU) told BBC News that the decision could have a trickle-down effect on state and local prisons, where more than 90% of US prisoners are held.
In prison systems “nobody ever wants to be the first” to make changes to policy, Mr Fathi says, so the states will be watching closely to see if the change in federal policy successfully cuts back on violence – and costs.
There were 94,365 prisoners being held in private facilities overseen by states in 2010, according to the Sentencing Project group.
During the Democratic presidential primary race, Hillary Clinton’s main rival Senator Bernie Sanders made a campaign promise to end the “private, for-profit prison racket”.
Senator Sanders sponsored a bill during his campaign attempting to end the use of private prisons in September 2015 saying “we cannot fix our criminal justice system if corporations are allowed to profit from mass incarceration”.
In a statement after the decision, Senator Sanders called the move “an important step in the right direction”, and that it is “an international embarrassment that we put more people behind bars than any other country on Earth… due in large part to private prisons”.