Only hours after a humiliating defeat on health care reforms had underlined his tenuous control over his party in Congress, Trump announced a second shakeup of his inner circle in barely a week. White House spokeswoman Sarah Huckabee Sanders said Kelly would start in his new post Monday.
Priebus has been under fire for weeks, seeing one White House ally after another resign or leave, culminating in the departure of press secretary Sean Spicer a week ago.
His exit appeared inevitable when Trump did not intervene as his new communications director Anthony Scaramucci publicly described Priebus as a "paranoid schizophrenic" in a foul-mouthed tirade that also saw him savage another top Trump aide.
Trump announced the switch on Twitter after a trip to New York, on which he was accompanied by both Priebus and Scaramucci.
"I am pleased to inform you that I have just named General/Secretary John F Kelly as White House Chief of Staff," Trump said.
"He is a Great American... and a Great Leader. John has also done a spectacular job at Homeland Security. He has been a true star of my Administration."
Kelly's Department of Homeland Security is responsible for enforcing border security and has taken a tough line on immigrants inside the United States.
The move likely signals a greater focus on law and order issues and will put further strain on relations between Trump and the Republican establishment.
Both Priebus and Spicer were part of the Republican National Committee, and the bridge that linked the party to Trump.
The announcement of Priebus's departure came only after three Republican senators defied White House pressure to vote against health care reforms, which experts predicted would have left millions more Americans without coverage.
The party rebellion -- led by Senators Susan Collins, Lisa Murkowski and John McCain -- is a deeply ominous sign for Trump, whose political brand is defined by his dealmaking acumen and a take-no-prisoners approach to politics.
For months, Trump has kept skeptical Republicans in line with an implicit threat that he would turn his diehard supporters against them.
Republican lawmakers had privately worried that even an angry tweet against them could spell disaster at the next election.
But there are growing signs those threats are losing potency, when Republicans not only killed efforts to dismantle Obamacare, but joined Democrats in supporting a new sanctions regime against Russia.
To veto or not to veto?
The sanctions bill -- which also includes measures targeting North Korea and Iran -- is designed to restrict Trump's ability to lift punitive measures on Moscow.
Trump now faces a choice between swallowing a bill he deeply opposed and refusing to do so -- a move that would intensify suspicions about his attitude to Russia and likely bring a humiliating veto override.
A source confirmed that the bill had now been passed to the president.
Trump's administration and his presidential campaign are under investigation by a special prosecutor and several Congressional committees over whether they colluded with Moscow to tilt the 2016 presidential election.
The new sanctions appear to have thwarted Trump's efforts to build better relations with Russia.
Russia's foreign ministry announced countermeasures, ordering Washington to reduce its diplomatic staff and seizing two US facilities.
Moscow ordered the US to reduce its diplomatic presence in Russia to 455 diplomats and staff and also barred it from using a Moscow summer house and storage facility.
Moscow complained that the "new sanctions bill showed with all clarity that relations with Russia have fallen hostage to the domestic political struggle in the US."
The grim news from Congress would have worsened the mood of Trump after an outburst from Scaramucci had shone a harsh spotlight on the divisions within his administration.
In an eye-watering exchange with a New Yorker reporter published late Thursday, Scaramucci described Priebus as a "paranoid schizophrenic" and chief White House strategist Steve Bannon as trying to build his own brand off Trump.
Scaramucci, a millionaire New York financier, arrived at the White House vowing to serve Trump's interest and right a badly faltering administration.
He did not apologize for the tirade, but said he would try to clean up his language in the future.
"I sometimes use colorful language. I will refrain in this arena but not give up the passionate fight for @realDonaldTrump's agenda," he tweeted.
(Except for the headline, this story has not been edited by NDTV staff and is published from a syndicated feed.)