Daley announced his decision during a press conference at City Hall.
"Now I am ready with my family to begin a new phase of our lives," Daley said, noting that he had considered the decision over the course of the last several months.
"I have always believed that every person, especially public officials, must understand when its time to move on," Daley said. "For me, that time is now."
Daley was elected mayor on April 4, 1989, to complete the term of the late Harold Washington, and was re-elected in 1991, 1995, 1999, 2003 and 2007 according to his biography.
Daley is the son of Richard J. Daley, who served as the city's mayor between 1955 and 1976.
The Chicago mayoral general election will be held February 22, 2011.
White House Chief of Staff Rahm Emanuel has in the past expressed interest in the job, telling Charlie Rose of PBS in April that, "[O]ne day I would like to run for mayor of the city of Chicago. That's always been an aspiration of mine even when I was in the House of Representatives."
In a statement released Tuesday, Emanuel did not indicate whether he will pursue the seat, but did say he was surprised by Daley's decision.
"While Mayor Daley surprised me today with his decision to not run for reelection, I have never been surprised by his leadership, dedication and tireless work on behalf of the city and the people of Chicago," Emanuel said.
With the election to be held early next year, Emanuel will have to decide quickly whether to stay at the White House or launch a bid for the office.
A source close to Emanuel tells CNN's National Political Correspondent Jessica Yellin that it's complicated. He takes his job seriously and feels a responsibility to see out his duties serving the President during difficult times.
The source added that he will probably look at the open seat as an option but has some time to make the decision.
But one group of progressives is already announcing their opposition to Emanuel.
The Progressive Change Campaign Committee circulated a petition shortly after Daley's announcement from Illinois voters who say they will "not to support Rahm Emanuel in any future election."
President Obama, a native of Chicago, praised Daley in a statement released Tuesday afternoon by the White House.
"No mayor in America has loved a city more or served a community with greater passion than Rich Daley. He helped build Chicago's image as a world class city, and leaves a legacy of progress that will be appreciated for generations to come."
– CNN's Jessica Yellin, Mark Preston, Adam Levy and Robert Yoon contributed to this report
Updated 5:36 p.m.