"The defendant is acquitted," presiding judge Enrico Tranfa said, requesting silence after gasps from the court.
The judge said there was "no crime" on the abuse of power charge and that Berlusconi's actions "did not constitute a crime" on the prostitution one, promising to publish a detailed explanation within the three-month legal limit.
Berlusconi's lawyer Franco Coppi said that the ruling had "exceeded our highest expectations", explaining that the judge may have recognised the defence argument that Berlusconi did not know the girl was 17 years old.
The 77-year-old billionaire tycoon left the centre at Cesano Boscone near Milan following the ruling without making any comments, while a lone supporter held up a sign reading: "Justice is served".
Also Read
Prosecutors had asked the judges to uphold the seven-year sentence for having sex for money with an exotic dancer called Karima El-Mahroug, who is now better known by her stage name as "Ruby the Heart Stealer".
Prosecutors, who had relied on telephone wiretaps and statements made and then denied by El-Mahroug, could now apply to the supreme court to review the ruling.
The ruling will have political repercussions, providing a respite from the legal storm around Berlusconi.
Ahead of the verdict, his Forza Italia party had been riven with internal divisions since a ruling against him would have opened the possibility of the ageing playboy being excluded from the political scene entirely.
Berlusconi is also currently on trial for allegedly bribing a senator with 3.0 million euros (USD 4.0 million) in 2006 to join his party and destabilise a centre-left government.