U.S. District Judge Henry Floyd in Spartanburg, S.C., said the government can not hold Padilla indefinitely as an "enemy combatant," a designation President Bush gave him in 2002.
"The court finds that the president has no power, neither express nor implied, neither constitutional nor statutory, to hold petitioner as an enemy combatant," Floyd wrote in a 23-page opinion that was a stern rebuke to the government. He gave the administration 45 days to take action.
"We think that this is a wonderful decision," said Padilla's attorney, Andy Patel, as Padilla waited on another line. "It is one of those moments that all Americans should be proud of."
The Justice Department did not immediately comment on the ruling.
The administration has said Padilla, a former Chicago gang member, sought to blow up hotels and apartment buildings in the United States in addition to planning an attack with a "dirty bomb" radiological device.
Padilla was arrested at Chicago's O'Hare International Airport in 2002 after returning from Pakistan. The federal government has said he received weapons and explosives training from members of al Qaeda.
Deputy Attorney General James Comey last year used a news conference to detail claims against Padilla. Comey asserted that if Padilla had been handled by the usual criminal justice system, he could have stayed silent and "would likely have ended up a free man."
During court arguments last month, his attorneys challenged the government to prove its case or release Padilla.
"If everything you say about Jose Padilla is true, prove it," said Denyse Williams, executive director of the American Civil Liberties Union in South Carolina, which has filed a brief in support of Padilla's attorneys. "Everybody says the war on terror could last a lifetime. If they can do it to him, they can do it to others."
David Salmons from the U.S. Solicitor General's Office countered at the time that the president has the right to detain any enemy combatant while the United States is fighting al Qaeda. But he added there's no risk that the president may round up citizens and detain them.
Padilla is one of only two U.S. citizens designated as enemy combatants. The second, Louisiana native Yaser Hamdi, was released in October after the Justice Department said he no longer posed a threat to the United States and no longer had any intelligence value.