The former policemen were accused of torture and other crimes while handing over the three brothers - Illy, Mehmet and Agron Bytyqi - to members of a special Serbian police unit who shot and killed them in a training camp in eastern Serbia.
"After questioning about 50 witnesses and experts, we have come to the conclusion that there is no evidence that they had committed crimes," said Vesko Krstajic, the head of the three-judge panel.
Serbia's war crimes prosecutor's office said in a statement later Tuesday that it would appeal the acquittal of Sreten Popovic and Milos Stojanovic, insisting that "the accused and the witnesses ... concealed the truth" during the trial about their participation in the killings.
The bodies of the brothers were discovered in 2001, bound and blindfolded in a trash-filled mass grave near the camp's fence, two years after they left their New York pizza business to join rebels fighting for Kosovo's secession from Serbia.
The Bytyqis joined the Atlantic Brigade of about 400 Albanian-Americans fighting with the rebels.
After NATO bombed Serbia to stop its crackdown on the rebels, the brothers strayed outside Kosovo's unmarked boundary. On June 26, 1999, they were arrested in southern Serbia.
They spent 15 days in a Serb jail for illegally crossing the border. Upon their release, they were taken by the two Serb policemen to eastern Serbia, where they were summarily executed.
No one has been charged with the shooting itself.
Members of the former special police unit allegedly involved have refused to reveal any details or names of possible culprits.
A lawyer for the brothers' families quit the trial earlier this year, claiming authorities are protecting those who ordered the killings.
The United States has demanded quick justice for the Bytyqi brothers, and has expressed frustration with the slow legal procedure. The trial began in 2006.
Kosovo declared independence from Serbia last year, but Belgrade has refused to recognize that status.
By Associated Press writer Dusan Stojanovic